Young & Invested: Are we too obsessed with investment fees?
Low costs are the key to success.
Welcome to my column, Young & Invested, where I discuss personal finance and investing for Gen Z and Millennials.
This column aims to be a resource for young investors navigating an ever changing financial, political and social landscape as they try to build wealth. Tune in every Thursday for the latest edition.
Edition 23
Like most West Aussies, I recently took a vacation to Bali – the land of the cheap and cheerful.
Although to my dismay, I’m not quite sure I can call it that anymore. A week doing mental currency conversions whilst adding service charges and government tax had me stressing about the price of everything from Bintangs to beach clubs. But ultimately, the experience was worth every penny.
This trip got me thinking about how we are often consumed by the price we pay for our investments and forget the important considerations such as the value we may derive from them. Despite inflation, wage growth and a plethora of other factors, fund fees have moved in the opposite direction than my favourite beachside Nasi Goreng (which seems to appreciate about 10% every year).
Insights from our US Fund Fee Study show that in 2024, the average expense ratio paid by fund investors was less than half what it was two decades ago. As a result, investors have saved billions in fees.
As someone who prefers broad-based index tracking investments, I often gravitate to products that are in the lowest fee quintile of their respective categories. But is it logical to entirely disqualify investments on an arbitrary percentage fee basis?
What has happened to fund fees?
In recent years, index managed funds and ETFs have experienced significant fee pressure. Most notably, providers of broad market index funds have been engaged in what has been dubbed a “fee war.” More recently, other asset managers have followed suit.
Figure 1: Fees continue to fall across the fund landscape. Source: Exhibit 6 Morningstar US Fund Fee study. Data as of Dec 31, 2024.
Humans have a natural inclination to assume that expensive = better. But is that the case with investing? Not really. Paying more often means getting less in return. Investors have largely taken this message onboard and clearly favour low-cost funds while rejecting more costly options.
Since 2000, net flows have trended higher for funds and share classes charging fees that rank within the cheapest 20% of their Morningstar category. Flows for the remaining 80% of funds have been negative in 10 of the past 11 years.
Figure 2: Investors overwhelmingly prefer cheap funds. Source: Exhibit 16 Morningstar US Fund Fee study. Data as of Dec 31, 2024.
So why has this happened? As we see above, fund fees drive flows. Our research has shown that fees are a reliable predictor of future returns with low-cost funds having a greater chance of survival and outperformance over more expensive peers. Therefore, investors are becoming increasingly aware of the importance of minimising investment costs.
Competition among asset managers have led many providers to cut fees. Fund fees are also being shaped by the evolution of the advice business. Many advisors are moving away from transaction-driven compensation models and toward fee-based ones with less costly funds and share classes seeing more flows.
Why are we obsessed with low fees?
I think most of us (including myself) are conditioned to be cautious of higher investment fees. And rather than attributing this to a simple pattern of behaviour, this aversion is also bolstered by research.
Morningstar research and academic studies have repeatedly demonstrated that fees are a reliable predictor of the future success of a fund. The chart below shows the cheapest quintile achieving a higher success ratio than the most expensive fee quintile.
Figure 3: Low costs are the key to success. Source: Morningstar Manager Research. Data as of June 30, 2024.
Besides the clear difference in success rates, higher fund fees (typically associated with active management strategies) have also been called out as a factor in the erosion of returns overtime. Logically, lower-cost funds have a greater chance of outperforming their more expensive peers due to the lower fee hurdle.
But we don’t just pay higher fees for no reason. Active managers justify the higher fees based on their conviction on achieving alpha or outperforming an index. However recent years have been a challenging time for non-passive players. Thus, the average active manager seldom delivers what they promise.
The impact of fee drag
Whilst an incremental difference of a few basis points between fees may appear negligible, it becomes a larger consideration (than transaction costs) when an ETF is intended to be held longer term.
If an investor is charged a 0.1% p.a. management fee vs. 1%, the extra 0.90% compounds over time, costing thousands in lost returns. Below is an example of $100k put into two funds, both returning 7% p.a. (before fees) over a 10-year period. The difference results in the more costly fund returning almost $16k less due to erosion from fees.
Figure 4: The compounding impact of fee drag. Author estimations.
But does this mean higher fees are always bad? Not necessarily. Sometimes paying more brings added value.Take luxury watches for example. I know I may insult some watch enthusiasts, but from a utilitarian perspective, there really is only one use for a watch – to tell time.
But as we know, there are a range of different brands serving the same purpose. So, what makes someone with good financial capacity buy a Rolex over a Seiko? Better brand name or recognition? The assumption of re-sale value/better ROI? Funds kind of work the same way. In a world of lower fund fees, how do we justify the higher ones? Through offering unique benefits that cheaper, passive products can’t deliver.
When paying higher fees may be worth it
Well regarded managers
I am usually quite disciplined when looking for ETFs for my own portfolio. I tend to fall into an indefinite rabbit hole of research which makes defining what I want and don’t want important. Low costs are key for investors like me with longer time horizons and therefore I usually don’t spare a glance at products that have a total cost ratio above 0.25% p.a. I realise this is probably a bit of a simplistic perspective given there are some quality picks at higher costs.
The SPIVA scorecard measures the performance of actively managed funds relative to benchmarks over various time horizons. It found that 83% of active funds underperformed the ASX 200 over a 10-year horizon. These numbers make it quite clear why active managers gain a bad rap but are also illustrative that well regarded managers with consistent outperformance do exist.
For example, Hyperion Asset Management has demonstrated an impressive lineup of strategies that consistently beats peers and indices. This resulted in them being awarded Morningstar’s Fund Manager of the Year award in 2025.
The fund introduced the Hyperion Global Growth Companies ETF HYGG in 2014 at an eyewatering total cost ratio of 1.9% pa. (management and performance fee)– well above the average active ETF fee of around 1.3% pa. Despite the significant fee hurdle, HYGG has a long record of delivering consistent alpha (net of fees) over its benchmark MSCI World ex Australia Index.
Figure 5: Growth of $10,000 invested in HYGG at inception. Source: Morningstar.
Figure 6: Trailing returns for HYGG. Data as of 30 June 2025. Source: Morningstar.
Over the trailing 10-year period to 30 June 2025, HYGG returned an annualised 19%. Comparatively, my personal low-cost ETF of choice for global exposure – Vanguard MSCI Index International Shares ETF VGS returned 13% over the same period.
Hyperion believes it has created an investing edge by identifying companies in the tech and consumer discretionary sector that have large total addressable markets, maintain strong competitive advantages, and can achieve high returns on equity. This depth of analysis and securing an investing edge is something that individual investors may struggle to achieve which therefore may justify the higher cost for some.
Of course, performance is all retrospective and there are likely numerous ETFs with consistently higher returns than HYGG. The larger point is that select active managers can outperform despite a higher fee level, but it can be incredibly difficult to pick the winners, especially when considering the majority underperform. In this article, Shani explores how to tell if a fund or ETF will likely underperform.
Considering other qualitative factors such as proven track record, the investment team, investment process, and parent organisation are also vital when determining a fund’s outperformance potential.
Niche markets
Higher fees may be justified when seeking exposure to niche markets or alternative assets. Research has proven that having a unique strategy or investing in areas with limited access has better allowed active managers to generate alpha over passive peers.
Our Active Passive Barometer report shows that managers excelin mid and small cap categories as broad-based indexes in this category are not as efficient. This allows active managers to exploit market inefficiencies and add value.
Figure 7: Morningstar Active Passive Barometer study. Data as of June 30, 2024.
Australian fund managers in these categories are better placed to hunt for attractive growth opportunities. In the long term we also see that excess return and success increases for active funds in this space. For investors seeking strategic exposure beyond basic market tracking, funds that operate in niches may prove more successful.
Key considerations
The one thing I’ve learnt here is that we can’t simply write off products with higher fees without exploring how they may cater to our goals. The reason I don’t hold any higher-fee, active ETFs in my own portfolio is that I do not require excess alpha over the market return to achieve my goal. However, this may not be the case for many.
Investors should ask themselves the following questions when evaluating whether to invest in funds with higher fees:
- How much alpha is required to achieve your goals, and can it be achieved through a lower-cost option?
- Has the fund consistently outperformed its own benchmarks and cheaper alternatives over the long term?
- Does the fund provide unique advantages/strategy or access that you couldn’t tap into through cheaper alternatives?
- Do you have the capacity to accept the risk associated with the fund’s strategy?
Higher fee products do outperform, but like all investments, they require due diligence on the part of the investor to determine whether they are better than a lower-cost alternative.
