2nd October 2013
Drilling down into the cost of investing in funds has always been a headache for many investors. But with predictions that returns may be subdued amid lower long term economic growth it may be more important than ever to keep control of costs writes Philip Scott.
The start of 2013 brought with it one the biggest upheavals the UK’s retail financial services industry has ever experienced and next year brings even more changes.
But will these changes lead to cheaper fund management or better value for money or better choices by investors.
The City regulator, the Financial Conduct Authority ushered in the Retail Distribution Review (RDR) with the aim of making the price tag for investing much more open and clear. Previously there was a perception among many investors that financial advice was free, as intermediaries earned a living from the commission providers such as pension firms and fund managers paid them.
But from the start of this year, the RDR has banned this practice. When it ushered in the RDR, the Financial Services Authority since renamed the Financial Conduct Authority, said that some of the less ethical financial advisers in the market were biasing their funds and pension recommendations towards those providers paying the highest commission.
Mindful Money contributor and certified financial planner at Chase de Vere, Patrick Connolly says: “The new rules have greatly empowered consumers. The RDR has meant that investors working with a financial adviser are benefitting from knowing exactly what they are paying and what they are getting in return.”
The upshot has been that investors now have to pay for advice either via a percentage fee or an hourly rate, which can typically averaging around £150. But naturally the situation has brought with it a new set of complexities.
Research from consultancy Deloitte in report published just before the RDR came into force forecast that the new rules could leave up to 5.5m Britons financially orphaned i.e. without an adviser.
The reasons were that many financial advisers and high street banks now say it is uneconomic to advice those with smaller amounts of money to invest. In addition, many investors will not want to pay advice through a fee or an adviser charge levied in funds under management.
For investors who want to get professional advice, it is important to shop around, and ensure they are truly independent. Many good advisers offer free initial consultations too. You can find an independent financial adviser in your locality at unbiased.co.uk.
The next stage: ‘Clean share prices’
But the RDR has not finished rolling out yet, as a new set of rules arrives in 2014 targeted at fund platforms and execution (non-advised) fund sellers. The first stage of the new laws banned financial advisers from taking commission for selling investments and pensions, so all fees paid by clients are clear and transparent and agreed in advance. But as a result of this, fund management firms asset managers have had to create what are known as “clean” share price for their funds – free of a commission element – for advisers to sell to their customers.
However the cheapest way to buy funds is typically via an execution only operations, often referred to as ‘fund supermarkets’ or discount brokers, which still do received commission from asset managers for fund sales, but this situation is due for its own shake-up next April, when a new set of rules, arrives which in industry circles is referred to as ‘The Platform Paper’. Some of the best-known companies in this arena include the likes of Hargreaves Lansdown, Charles Stanley Direct, Bestinvest and Chelsea Financial Services.
When buying a fund from a discount broker, consumers typically just see a set fee. But they do not know how much of this cost goes to the broker and much is with the fund manager. The arrival of RDR 2 will mean execution only services will have to engage in ‘clean pricing’ i.e. disclose the split between what they and the provider are individually receiving.
Hopefully this will mean a much better deal for investors, given that execution only services such as fund supermarkets will have to ensure they are pricing themselves competitively.
Some discount brokers have already taken pre-emptive action. For example, Charles Stanley Direct, which launched earlier this year, with the cost of investing in a fund generally at 1% a year is made up made up of a 0.75 per cent going to the fund manager and the 0.25% to the platform.
Connolly adds: “In regards to execution-only brokers, who transact business through their platforms, direct with consumers, but do not provide any financial advice, it is imperative that investors dig down to see exactly what they are paying when using a discount or financial adviser. Add-up what all charges and fees are going to come to.”
For the “orphans” perhaps looking to go it alone when it comes to making investing investment decisions, Mindful Money breaks down the jargon and looks at the main costs involved when it comes to investing in funds as paying over the odds may hurt your returns, possibly severely so in the long run.
Initial charge: This fee is generally around an eye-watering 5% of the initial investment. This is a single, one-off upfront cost generally only levied if you go directly to the fund provider – which is never recommended, as a decent discount broker will cut the initial charge to zero.
Annual Management Charge (AMC) / Total Expense Ratio (TER): Generally about 1.5-1.75% for an actively managed fund, but again a fund-supermarket may help lower the fee. But this is only part of the story as the Total Expense Ratio (TER) sometimes known as an on-going fee is a better representation of the bottom line cost as it takes into account the annual management charge alongside ‘hidden’ costs such as dealing and regulatory fees, incurred by a fund, which can add another 0.1% – 0.2% to the annual charge. Tracker funds, which mirror the performance of a particular index, such as the FTSE 100, are cheaper, costing around 0.2% a year while actively managed funds tend to be around 0.75% to 1% a year for ‘clean’ versions, if bought via a fund-supermarket or discount broker, the main choice most for most UK investors. Of course the cost of investing with these businesses will depend on what you buy.
Best platform deals
Of course what you use a platform for, be it to invest your Isa or pension will depend on what you ultimately pay. The online specialist comparison service
www.comparefundplatforms.com, is a very good place to start. For example it finds that Alliance Trust Savings, Sippdeal and Cavendish Online tend to be amongst the most competitive for direct and ISA holdings. Alliance levys £48 a year, Sippdeal charges £50 a year and on Cavendish most actively managed funds come out at around 1% a year.