Are City fees damaging our pensions?

20th December 2011

It claimed that there was an additional 0.3% for registrars and other ancillary fees plus a further 1.4% for "trading" – the charges levied each time a fund's portfolio changes. It suggested these amounts are "hidden".

This story follows articles examining how much goes in fees each year in the The Financial Times and other newspapers.

The concern is while returns on equity, bond and other investments are lower now than in the past, the amount taken in fees has remained unchanged or has, in some instances, risen.  For instance, a plain vanilla fund with an annual management charge set at 0.75% in the mid 1980s now charges 1.5%.

But from the start of 2013 – a year's time – investors will get a chance to see what happens to that 1.5% and possibly to challenge some or all of these costs. It's all part of the big change to financial advice known as the Retail Distribution Review (RDR).

Perhaps unsurprisingly, The Investment Management Association slammed the Observer story as "irresponsible scaremongering, yet again" – the "yet again" presumably referring to other media stories. It points out that nothing is hidden – all the relevant figures are disclosed somewhere. But it does not mention that there has been little, if any, competition on price. While investors may be able to find the information – often after buying the fund – they may not be able to act rationally on it.

The Observer story failed to point out that trading costs vary greatly from fund to fund depending on its turnover of shares each year.

Nor did it break down the annual management charge into constituent parts, however. That 0.75% from 25 years ago has not changed for most fund managers. What has altered is that advisers who sell funds now expect to be remunerated each year instead of upfront when the fund is purchased. In the past, they took 3% at the start – now most have foregone initial charges in return for 0.5% a year as long as the fund is held. So once a fund is held longer than around six years, the investor starts to lose out.

On top of that adviser charge, the platform which sells the shares to investors or advisers collects a further 0.25%.  Both these charges – amounting to 0.75% – come out of the 1.5% annual management charge. 

Again, investors who have held units for a long time – possibly from when charges were lower – are paying the current higher fees. Additionally, fund purchasers who bought without advice and receive no continuing advice are still paying the 0.5% "trail commission" and the 0.25% to a platform even if no one is picking this up.  The money stays with the fund management company which currently decides how the annual charge is divided.

Come RDR in 2013, however, and the situation changes. Instead of the product provider deciding on the breakdown, the dynamics are flipped, leaving the adviser (and possibly the individual investor) in the driving seat. Charges will be unbundled – fund management, adviser fee, platform charge.

"This may not necessarily save investors money, " says Robin Stoakley, head of UK Intermediary at Schroders Investment Management. "But advisers, who effectively own the clients, will look to come up with lower total charges as this will boost client returns. They will become sensitive to price so there could be negotiation. Some will recommend lower cost funds such as trackers as part of an diversified portfolio structure to get overall expenses lower."

Trackers, which mimic an index such as the FTSE100 or the FTSE All Share, typically have annual fund manager charges of around 0.30% before adviser or platform fees.

But many advisers are not fans of index funds – some say trackers are forced to buy unsuitable or overpriced shares leading to price inefficiencies while they may also feel recommending a passive holding is an abdication of their role in helping clients.

So enter the low cost fund – typically with fund manager charges of around 0.4% instead of the more usual 0.75%. A number of UK fund managers have – or intend to – introduce small fee funds to their range. 

"Fund management firms including ourselves came to the view that advisers would prefer active to passive providing fees are competitive," says Stoakley.  "We offer three low cost funds – UK Core, Global Core, and Dynamic Multi-Asset – with annual fees between 0.4% and 0.5%. These funds are lower risk and designed to outperform the relevant index by about 1% a year.  We can offer these at a reduced rate because we already have these funds so there is no need for extra managers or other new costs.  It is about economies of scale."

Investors who buy low cost funds through an adviser will still have to negotiate and pay adviser and platform charges. But those happy to take care of their own strategy will be able to buy these funds from the firm's website, by-passing adviser and platform charges. That way, they will start each year with a 1.1% advantage over traditional funds.

Schroders estimates that the current 12% of investor money in low cost funds, mostly trackers, will double to 25% over the next few years as cut fee vehicles gain market share.


More from Mindful Money:

RDR: Who is doing what to educate consumers?

Is it time to re-examine board composition in UK companies?

Does ‘crowdfunding' stack up for investors?

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