13th November 2013
At times, it can seem like fund managers are engaged in one giant conspiracy on fund charges. From broker commissions to hidden dealing costs, it is tempting to believe that the fund management industry is awash with undisclosed costs that threaten to wreak havoc on individuals’ long term savings. Is this the case? What do investors really need to know about costs?
Investment journalist Cherry Reynard gives her view.
The controversy around fund manager costs has reared its head several times over the past few months. First pension fund managers were put under pressure to come clear on charges, on worries that workers were being over-charged for workplace pension schemes. The timing was unfortunate, coinciding with an advertising push for auto-enrolment as FT.com reported.
At the same time, all fund managers were put under pressure by the FCA, who believes there should be greater disclosure on broker commissions. These are payments made to brokers by fund managers in exchange for research and trade execution. The FCA believes that these payments should not be passed on in full to the end client and fund managers should be absorbing more of the costs themselves as reported by Reuters.
A crack-down on these types of costs has long been called for by someone who is arguably a poacher turned gamekeeper Alan Miller. Miller had been an active manager at New Star, but grew disillusioned and is now a high profile campaigner for the full disclosure of fund management costs. He now runs entirely passive portfolios at his own company SCM Private.
In one of his more recent pieces he looks at charges in the IMA’s targeted absolute return sector – Ft.com. He wrote: “The City Financial UK Equity fund cites an AMC of 1.5% per annum. However, once ongoing charges, underlying trading costs and performance fees are added (assuming the fund returned 5 per cent a year) the total cost for the investor rises to 5.57 per cent a year”.
These costs are certainly high. Indeed, it may sound like there is a crisis in fund management, with managers greedily creaming off fees to rival energy firms, but before sticking everything in a passive ETF, it is worth remembering that there is another side to the argument.
Firstly, all of the major statistics providers quote performance statistics after fees have been deducted. This means that if a fund is high-charging and not adding value for those additional costs, it will be reflected in weak fund performance. For example, while the charges on the City Financial UK Equity fund are undoubtedly high, it has delivered a return of +78.8% over five years compared to an average return from the UK targeted absolute return sector of +23%. It is a small fund at £35.5m and as a result will have high fixed costs as a percentage of assets. This will drive the total expense ratio higher, but it may not mean the fund will be permanently high charging.
Part of the problem with higher charges is that some people believe that no active manager can add value. The market is a zero sum game, therefore the average active manager can only ever deliver the market return less (higher) fees. Therefore anything an active fund manager charges over a passive manager is essentially deemed a waste of money. It is certainly true that when investment adviser commissions were factored into the cost of buying a fund, it was difficult to find a fund that could merit the higher costs. Few funds were good enough to justify 5% upfront, plus an annual management charge of 1.5%.
But now that adviser commission is no longer charged on ‘clean’ share classes, the costs of active management start to look far more reasonable to the extent that it is arguable that passive funds are starting to lose their edge. Research by Morningstar reported by FT.com, shows that average retail equity index funds has a total expense ratio of 0.73%. The cheapest ‘clean’ share classes, such as those offered by Investec Asset Management have an annual management charge of 0.65%, with 0.75% now commonplace. Yes, there will be other expenses on top to give a higher total expense ratio, but it still looks like, in some cases, investors are getting active management for a reasonable price.
The investment trust sector has also started to shape up on costs. Morningstar research shows that trusts are increasingly scrapping their performance fees and lowering their annual management charge in a bid to remain competitive with the new share classes on open-ended funds. Even big providers such as Baillie Gifford have seen it necessary to take this step.
Now the trade body, the IMA is campaigning to for fund managers to provide a fully inclusive and transparent cost figure – as chief executive Daniel Godfrey puts it: “a simple, all-inclusive, pounds and pence number that will give investors a good sense of what the cost of holding units in a fund has been and which they can compare to their investment return to begin to get a sense of value”, as he writes on his blog.
Godfrey also points out that the fund industry has been a target because there are a complex set of costs borne by funds. That can give the impression of opacity and the industry needs to do what it can to counter that accusation.
Costs are important, but the majority of fund managers are not trying to rip off their clients and there are an increasing number of good funds at low cost being provided by the major fund houses. Whether looking at active or passive funds, investors need to ensure that – where possible – they are in the lowest cost share class (and that applies to existing fund holdings as well) and also are not paying more than the standard rate, unless they believe they have a truly outstanding manager who is worth the price.