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11 May 2011 | Business

Lifting the Lid on Investment Charges 

Lifting the Lid on Investment Charges
Transcript (pdf) Comments (1)

WHEN it comes to investing, we all want the same
thing: to maximise profits and minimise losses. But
how many investors know the impact that fund
management fees have on their returns, asks
Jennifer Hill?

You might not realise it, but high charges can eat up a significant amount of your investment returns over time.

Simon James, a founding partner at Gore Browne Investment Management, said: “One of the biggest challenges facing the market is a lack of transparency over charges.

“It’s not simple for investors to find the total expenses ratio, which should show the real cost of an investment fund.

“While it’s not hard to provide this information, the wealth management and fund management industry as a whole has been very poor in both providing and communicating this.”

Government caps fees

The government has taken steps to try to limit fund costs – and encourage more people to invest, particularly for their retirement.

When it launched the long-awaited stakeholder pension in April 2001 it capped the fees that providers could charge at a maximum of 1% of the value of an investor’s pension fund each year.

A new low-cost pension scheme, the National Employment Savings Trust (NEST), which employers will start to introduce from October 2012, will charge just 0.3% annually on a member’s funds under management, and an initial charge of 1.8% on contributions.

However, many product providers still charge far more than 1% a year in ongoing charges, particularly those running ‘zombie’ funds. These are with-profits funds that are no longer open to new business, and can be pension or investments funds, like bonds and endowments.

They are called ‘zombies’ because investment experts view them as the living dead of funds. Often, exorbitant charges coupled with paltry returns (as investments are left to gather dust) mean people’s investments are losing money year after year.

Douglas Baillie, founder of, the online pension switching service, said: “So called ‘zombie’ funds, such as those run by Royal London and Pearl, are by far the worst offenders.

“These companies are clearly relying on a lack of understanding and inertia by investors, while they take actions that significantly erode people’s wealth.

“If you have old legacy with-profits policies, it’s time to wake up and realise that these companies aren’t the cosy, trusted mutuals or friendly societies that once encouraged the average working person to save. These are now either listed or private equity-owned companies with high-profit motives.”

Acronym central

So just what are you charged when you invest? Firstly, there is the annual management charge or AMC. This is the fee that the fund company charges annually to manage the fund.

About two thirds of the typical AMC (in the region of 1.5%) is used to pay for research, wages and costs associated with physically managing the money. The remaining 0.5% is paid out as annual trail commission to independent financial advisers or to the fund platform through which the fund has been bought.

If you are charged an AMC of 3%, in 30 years’ time you’d have retained just 40.1% of your initial investment after costs. If the AMC was just 1%, you’d have kept 74%, data from Vanguard, the tracker fund provider, has shown.

The AMC is the figure that is usually published on fund factsheets and is the fee that most investors – incorrectly – understand to be the amount they pay each year.

The total expense ratio, or TER, is a more accurate reflection of the total cost. It includes the AMC, as well as other charges, such as share registration fees, auditing costs, custodian and legal fees. It is calculated by dividing the total annual cost by the fund’s total assets averaged over a year.

Fund managers aren’t obliged to reveal their TERs, yet they directly affect investors’ returns. If a fund generates a return of 7% and has a TER of 4%, your net gain is just 3%.

Even TERs don’t give the full picture. In particular, they don’t take account of the portfolio turnover rate (PTR). A fund that buys and sells a lot and has a high turnover rate will clearly incur more transaction costs than one with a lower turnover rate.

At least 0.2% of returns are lost for every 10% of turnover, according to figures from Frontier Investment Management1. These transaction costs rise in less liquid markets, such as emerging markets, where a PTR of 10% will cost you 0.8%.

A UK large cap fund with 200% turnover – meaning that the average asset in the portfolio is bought and sold every six months – will incur additional costs of 3.1% a year, while an emerging markets fund with the same level of turnover will add 11% to fees. With an average TER at 1.3% for a large cap fund and 2% for an emerging markets one, you’d need returns of 4.4% and 13% respectively just to break even.

Industry takes action

Amid criticism, the fund management industry has itself taken steps to improve transparency on fees. In October last year, respected fund manager Crispin Odey unveiled a new onshore wealth management business with flat annual management fees of 1%.

A statement from Odey Asset Management said the new firm, Odey Wealth Management (UK), would aim to address the “raw deal offered by the current crop of bloated wealth managers”. It said that too many of them siphon off high – and often hidden – charges, while delivering little in the way of profits.

Odey, known for his success running hedge fund-type products, said: “I’m calling an end to the raw deal served up by many providers in the wealth management industry. The big bank model died in 2008. Too many so-called professional investors embrace mediocrity by seeking consensus views that starve private clients of performance whilst lining the managers’ pockets with high and often hidden charges.

“Private clients want to buy a fund manager’s judgement not an endless choice of ways to lose money.”

Tim Bond, formerly head of global asset allocation at Barclays Capital, joined the firm as chief strategist, while Peter Martin, ex-managing director of Rothschild, became senior portfolio manager.

Paying 1% for the expertise gleaned from Odey Asset Management’s research is a lower price to pay than that charged by most big banks’ wealth management divisions – provided there are no further underlying charges.

David Stewart, chief executive of Odey Asset Management, told the Financial Times that they expect to attract investors with £500,000 to £1 million to invest who have become “disillusioned with high fees and poor returns”. At that level, Odey stands to make at least £5,000 per year per investor – still not exactly small change.

Dawn of new era

James, at Gore Browne, concurs with Odey’s view that the industry has much to do in order to improve its overall service, but believes “the first step shouldn’t be towards bespoke style offerings, but on removing confusion, discontent and unfairness around fees and charges”.

Thanks to the Retail Distribution Review (RDR), independent financial advisers will no longer be paid in the form of commission from investment product providers from 2013. Instead, they will have to be paid in fees charged direct to their clients.

The legislation is poised to herald the arrival of a new era in investment management. Realising that they can no longer use commission as a sales tool, fund groups are making tentative steps towards cutting charges to attract customers directly.

JP Morgan Asset Management launched a low-cost, actively-managed fund earlier this year, which it claims to be the first ‘RDR-ready Oeic’. On 1 February the JPM UK Active 350 fund was renamed the JPM UK Active Index Plus fund, with a significantly reduced AMC of 0.25% per year and fixed expenses of 0.15% – so a total of just 0.40%.

Meanwhile, Schroders has launched two funds in what it says will be a suite of actively-managed products designed to provide customers with a low-cost, lower-risk, transparent alternative to passive investing.

In March, it launched the UK Core fund, run on RDR-friendly principles with a TER capped at 0.40%, followed by a retail share class of its QEP Global Core fund, also with a TER of 0.40% and no initial charges.

The former targets a 1% outperformance net of fees of the FTSE All-Share index, while the latter aims to outperform the MSCI World or equivalent indices by 1% gross of fees by investing in over 500 global stocks.

Investment trusts excel

Out of 225 global growth oeics, unit trusts and investment trusts, more than 30 have a TER of less than 1%, according to a recent analysis by Stuart Coyne, technical marketing co-ordinator at Baillie Gifford. Seven out of 11 of the cheapest 5% of funds are investment trusts, he found.

Some of the UK’s oldest and largest investment trusts, such as Scottish Mortgage, managed by Baillie Gifford since its launch in 1909, and British Assets, managed by F&C since launch in 1898, are among the cheapest.

In the latest analysis, Scottish Mortgage is ninth overall with a TER of 0.56%, while British Assets is the 11th cheapest, with a TER of 0.62%.

Coyne, who undertakes this analysis of global funds every six months, said: “As our data consistently shows, big investment trusts are amazingly good value. Many of them rank among the top 5% of all funds – so are resolutely low-cost.”

Other Baillie Gifford investment trusts also fare well on the fees front: Monks Investment Trust has a TER of 0.64%, Mid Wynd International Investment Trust of 0.88% and Scottish American Investment Company of 0.98%.

Cheapest isn’t best

Of course, there are plenty of cheap tracker and exchange-traded funds (ETFs) on the market, but by their very nature they can’t outperform the index or the asset class they track.

Investment choice should not just be about price: returns count too. Research released in March by Collins Stewart showed that more than three-quarters of closed funds (so, investment trusts) have outperformed open-ended funds (unit trusts and open-ended investment companies). Moreover, out of 22 investment companies featured in its report, 21 had lower management fees – by an average of 0.63% and a maximum of 1.11%.

“Given the proven track record, significant valuation differentials in most cases, much lower management fees and the potential for NAV [net asset value] enhancements through the use of gearing and share buybacks, we struggle to see how so called ‘independent’ advisers can continue to ignore the closed-end industry,” the report said.

“Although RDR represents a great opportunity for the investment company sector, we wonder what appetite the fund management houses will have for selling these lower-margin products.”

Other ways to cut costs

While it can make sense to pay a little more for good performance, it’s also wise to avoid expensive actively-managed funds that have failed to deliver.

For example, absolute return funds – which are supposed to be uncorrelated from other asset classes and provide positive returns in all environments – have largely mirrored the performance of the FTSE 100 index, research by AWD Chase de Vere, the adviser, has shown.

Its head of communications Patrick Connolly said: “The investment industry is very keen to promote these funds as they can include hefty performance fees which make them very profitable.

“It is the investor that is most likely to lose out as they pay higher fees for performance which may not live up to their expectations.”

You can also cut costs by investing online and hunting down the most competitive investment wrappers. These include many proprietary savings schemes from investment trust providers. For example, Baillie Gifford’s Investment Trust Share Plan and Children’s Savings Plan have no initial fees, annual management charges or dealing costs although other charges include the dealing price spread and stamp duty costs of 0.5% on purchases.

You can invest a lump sum of £250 or monthly savings from £30 in the former, and lump sums of £100 and monthly savings from £25 in the latter, which can be opened for any child under 18. Baillie Gifford’s investment trust ISA and ISA transfer service similarly has no initial charge and an annual management charge of just £32.50 plus Vat.

Go online

The number of investors who bought their last individual savings account (ISA) online through a fund supermarket or through a broker is up 37% in the past year to more than one in two (51%). In contrast, the proportion of people buying an ISA from a bank has fallen from 42% to 31%, according to research by Interactive Investor.

Rebecca O’Keeffe, Head of Investment at Interactive Investor, said: “The shift towards online ISAs mimics the online shopping trend and confirms that investors are increasingly confident about investing and trading online. Investors are also more aware of the fees they have to pay on their investments and are looking for lower-cost options.”

The latest figures from Hargreaves Lansdown, the independent financial adviser, also suggest a growing number of investors are buying actively-managed funds through fund supermarkets.

The value of assets held on its private investor platform, Vantage, rose 6% from £20.9 billion to £22.1 billion in the three months to end-March 2011, due to net inflows of £1.1 billion and positive market movements of £100 million. The number of active clients rose by 20,000 to 366,000.

The final word

Danny Cox, head of advice at Hargreaves, told Trust Online that “low-cost tracker and ETFs are a cost-effective way to obtain exposure to any given market, but the downside is that they will never outperform.”

“For this you need active management through funds like investment and unit trusts: some actively-managed funds significantly outperform their benchmarks over time and are well worth their additional fees,” he said.

“A growing number of investors are realising that they can get active management – and the chance to beat the market – while still keeping a careful eye on overall costs.

“Investment fees and charges reduce the overall returns on your investments, which is why it is important to buy your funds through a fund supermarket.”

“As the name suggests, these provide a significantly greater choice of investment than the traditional way of buying a fund direct, and investors can also take advantage of their purchasing power to keep all-important costs to a minimum.”

Past performance is not a guide to future performance. Stock market investments and any income from them can fall as well as rise and investors may not get back the amount they invested. Changes in the rates of exchange may cause the value of investments to go down or up.

Author: Jennifer Hill
Jennifer is an award-winning British financial journalist. She recently left The Sunday Times, where she was deputy Money editor, to set up her own company, mediahill Ltd. She is a previous personal finance correspondent of Reuters, the global news service, and personal finance editor of The Scotsman newspaper.

She has won or been shortlisted for six Headlinemoney awards, the ‘Oscars’ of personal finance journalism in the UK. She has also scooped or been nominated for accolades from the Association of Investment Companies, Ignis Asset Management, the Association of British Insurers and the British Insurance Brokers’ Association.

You can read more articles from Jennifer in her regular Trust Online column 'Capital Hill'. 



post a comment »

An interesting article on a vital issue. I do think that reference should also be made to companies that rebate trail commissions. For example Hargreaves Lansdown rebates about 20% of these but much better still is Alliance which rebates 100% of unit trust trail commissions although they do charge £12-50 to buy or sell unit trusts.

Graham Williams

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