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interview part 1: comparing the UK and US

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Last Friday I interviewed Christopher Traulsen from Morningstar UK. This is the first part of the interview. I’ll post the second and third parts tomorrow and Wednesday.

Christopher started of by stating that his philosophy for individual investors is that they should take the long term view, be well diversified and look to add value over time.

Morningstar is an American company, as is Christopher Traulsen so first I asked him what he thought were the major differences between the US and UK investment markets. He started by saying that broadly speaking the types of investments available in the UK are similar to those in the US – although they might be named differently.

However, in the US, Traulsen gave the opinion that there is a much more robust individual investor culture and that this is influenced to a large degree by the growth of 401(k) plans and that in addtion there is less onerous regulation. Also, perhaps because of previous mis-selling scandals the FSA in the UK has ring-fenced advice – this may be having the unwanted side effect of making opinion and advice on investments difficult to get.

Given that 401(k)s are similar to direct contribution pension schemes, I asked Christopher whether he thought that there might be a similar growth in individual investor culture in the UK and he seemed quite hopeful.

The other main difference between the UK and the US that we discussed was the level of fees that are charged on funds – with the US having much lower fund charges. For example there is an index fund tracking the S&P 500 (similar in scope to the FTSE All Share but US companies) that has a total expense ration of 0.09%. The cheapest FTSE All Share index that Christopher could find in the UK is the Fidelity Moneybuilder UK Index with a total expense ratio of 0.30%.

I asked why he thought that funds were so much cheaper in the US. The possible reasons that he gave are partly because the UK market is so fragmented, and so funds are smaller. This means that there aren’t the same economies of scale that you can see in the UK. In addition competition on the fee front is low. 65% of UK domiciled funds investing in UK equities have an annual management charge of 1.5%, whereas in the US there is a much larger spread of fund charges.

One of the consequences of the higher fee rates that Christopher highlighted is that it means that fund managers in the UK need to take greater risks to make gains – for example there is a Newstar American fund whose stated aim is to invest in the North American market that has a total expense ratio (TER) of 2.73%. To try to generate good returns they have invested in Latin America, not a bad thing in itself but not exactly within the stated aims of the fund.

We then discussed what might bring costs down in the UK. Christopher suggested that part of the problem of may be a lack of transparency in funds and fees and also that investors don’t always realise that fund costs should be compared on the basis of TERs – including all the trail commission as well as the annual management charge. He also stated that one of the features that Morningstar’s analysis of data in the US over the last 25 or so years is that past performance is not a good guide to future performance and that the best indicator is fee levels.

In addition in the US funds have boards that represent the investors and hire fund managers to run the fund. The management contract often has a sliding scale of fees for the fund manager so that as the fund gets larger the percentage that is paid to the fund manager drops. This is better for investors but doesn’t impact too greatly on the fund managers are there are economies of scale in a large fund.

Its Christopher’s hope that competition between domestic funds and offshore funds will drive down fees here in the UK.

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