Driving down the costs of fund management Merryn Somerset Webb, editor-in-chief, MoneyWeek
Ever had the feeling that your fund manager is getting rich faster than you are? If so, you are on to something. He or she probably is. The charges on the average fund in Britain are very high indeed. You may or may not pay a fee to buy the fund in the first place but once you are in you will pay something in the region of 1.5 per cent a year in management fees plus another 0.5 per cent. That might not sound like much but it really adds up. Invest £20,000 for ten years in a fund with costs that work out at 2 per cent and you’ll have £32,200 at the end (assuming a very generous 5 per cent growth rate). Invest it in a fund with costs of 1 per cent and you’ll have £35,600. Until recently not many investors asked much in the way of questions about these charges or about their impact on the long-term performance of their investments.
Now they are beginning to. You can see why. During the great bull market of 1980-2000 everyone made money. Most funds went up most years and it didn’t seem nuts for fund managers to both promise and then to deliver regular returns of anything from 8 per cent upwards. And when people were making that kind of return the fact that the odd 2 per cent was being skimmed by the managers seemed by the by. No more. Over the last ten years most fund managers have utterly failed to produce a real return (after taking inflation into account). That has made the dismal compounding effect of their overblown fees on our money all too obvious. They have always known they charge too much for doing a job that is as much a mix of admin and luck as anything else. Now we know. And they know we know.
It used to be that when fund managers came to see me to pitch a new launch they started out by telling me about their new and clever strategy. Now they save that bit for later and they tell me the price first—and that price is coming down. I rarely meet a manager with the gall to charge over 1 per cent and I often meet managers looking to charge less. The most interesting launch of last year came from Fundsmith’s Terry Smith. His fund charges a flat 1 per cent if you buy it direct. It doesn’t attempt to supplement that price with a performance fee and it also commits to trading as little as possible in order to keep costs down. Other funds such as those run by TCF Investments commit to reducing their take as their fund grows: the idea is to get them down to 0.6 per cent a year. However that’s not as cheap as you can go. The arrival of simple exchange traded funds (effectively listed funds tracking various indices) into the British market over the last decade has put further pressure on the traditional industry. These days if you buy a tracker fund from one of the big providers the charges will be almost negligible. The Fidelity Money Builder UK will take your money for a mere 0.27 per cent a year for example. That’s a major improvement on 2 per cent.
Changes to the rules might make it harder to get good adviceTony Stenning, head of UK retail, BlackRock
It is vital to encourage people to save much more for their retirement, given the rise in longevity, the increasing pressures on scarce state resources to fund pensions and the fact that final salary schemes that once promised a decent standard of living in old age are now unaffordable.
The problem is that the best places to save money—equity and bond markets—have been exceptionally volatile. So how can we reconcile the need to invest, with the need for safety?
Good professional advice is crucial and it is hoped that the Retail Distribution Review (RDR), a long-running and as-yet-incomplete piece of consumer protection regulation, will improve the advice available to British investors.
There are two main tenets of RDR. The first is to stop product providers paying commission to financial advisers who recommend their products. Advisers must offer unbiased advise to clients and commissions will be replaced with fees for advice that are agreed with the client upfront.
The second tenet is to improve the advice available by making qualifications tougher. The deadline for the implementation of these and other RDR measures is 31st December 2012. It sounds good so far—so what’s the catch?
The main problem is the unintended consequence of moving to a fees-only system. Currently, on a typical annual charge of 1.5 per cent of a fund’s value per year, one third of that may be paid to an adviser in commission. Under RDR, the client will pay the adviser directly, creating a bill that could amount to hundreds or thousands of pounds. But many consumers will not be able to afford advisers’ fees if they are forced to pay cash upfront. This may make financial advice only available to the wealthy and exclude the less well-off.
Advisers whose client bases include the less well-off may be forced to leave the industry. A report in July 2011 by Aviva claimed that up to 3m people could struggle to find good quality guidance as advisers drop lower-income clients. Meanwhile, advisers without the necessary qualifications now have less than 11 months to gain it. Industry participants fear this may lead to a wave of early retirement among advisers. Financial institutions are cutting levels of advisers.
A further side-effect of RDR will be the growth in sales of investments that can be sold without advice, or “execution-only” business. It means a potential boost for a fast-growing section of the investment market known as Exchange Traded Funds (ETFs), which can be sold without advice. But this does not necessarily mean it is in the public’s interest if they don’t fully understand what they’re buying.
It is hard to argue that investors do not need more protection—but the RDR might have precisely the opposite effect. We should not lose sight of the fact that any market-based investment always contains some risk; the important thing is to educate investors about what markets do without frightening them away from the need to save for their long-term wealth.
Ever had the feeling that your fund manager is getting rich faster than you are? If so, you are on to something. He or she probably is. The charges on the average fund in Britain are very high indeed. You may or may not pay a fee to buy the fund in the first place but once you are in you will pay something in the region of 1.5 per cent a year in management fees plus another 0.5 per cent. That might not sound like much but it really adds up. Invest £20,000 for ten years in a fund with costs that work out at 2 per cent and you’ll have £32,200 at the end (assuming a very generous 5 per cent growth rate). Invest it in a fund with costs of 1 per cent and you’ll have £35,600. Until recently not many investors asked much in the way of questions about these charges or about their impact on the long-term performance of their investments.
Now they are beginning to. You can see why. During the great bull market of 1980-2000 everyone made money. Most funds went up most years and it didn’t seem nuts for fund managers to both promise and then to deliver regular returns of anything from 8 per cent upwards. And when people were making that kind of return the fact that the odd 2 per cent was being skimmed by the managers seemed by the by. No more. Over the last ten years most fund managers have utterly failed to produce a real return (after taking inflation into account). That has made the dismal compounding effect of their overblown fees on our money all too obvious. They have always known they charge too much for doing a job that is as much a mix of admin and luck as anything else. Now we know. And they know we know.
It used to be that when fund managers came to see me to pitch a new launch they started out by telling me about their new and clever strategy. Now they save that bit for later and they tell me the price first—and that price is coming down. I rarely meet a manager with the gall to charge over 1 per cent and I often meet managers looking to charge less. The most interesting launch of last year came from Fundsmith’s Terry Smith. His fund charges a flat 1 per cent if you buy it direct. It doesn’t attempt to supplement that price with a performance fee and it also commits to trading as little as possible in order to keep costs down. Other funds such as those run by TCF Investments commit to reducing their take as their fund grows: the idea is to get them down to 0.6 per cent a year. However that’s not as cheap as you can go. The arrival of simple exchange traded funds (effectively listed funds tracking various indices) into the British market over the last decade has put further pressure on the traditional industry. These days if you buy a tracker fund from one of the big providers the charges will be almost negligible. The Fidelity Money Builder UK will take your money for a mere 0.27 per cent a year for example. That’s a major improvement on 2 per cent.
Changes to the rules might make it harder to get good adviceTony Stenning, head of UK retail, BlackRock
It is vital to encourage people to save much more for their retirement, given the rise in longevity, the increasing pressures on scarce state resources to fund pensions and the fact that final salary schemes that once promised a decent standard of living in old age are now unaffordable.
The problem is that the best places to save money—equity and bond markets—have been exceptionally volatile. So how can we reconcile the need to invest, with the need for safety?
Good professional advice is crucial and it is hoped that the Retail Distribution Review (RDR), a long-running and as-yet-incomplete piece of consumer protection regulation, will improve the advice available to British investors.
There are two main tenets of RDR. The first is to stop product providers paying commission to financial advisers who recommend their products. Advisers must offer unbiased advise to clients and commissions will be replaced with fees for advice that are agreed with the client upfront.
The second tenet is to improve the advice available by making qualifications tougher. The deadline for the implementation of these and other RDR measures is 31st December 2012. It sounds good so far—so what’s the catch?
The main problem is the unintended consequence of moving to a fees-only system. Currently, on a typical annual charge of 1.5 per cent of a fund’s value per year, one third of that may be paid to an adviser in commission. Under RDR, the client will pay the adviser directly, creating a bill that could amount to hundreds or thousands of pounds. But many consumers will not be able to afford advisers’ fees if they are forced to pay cash upfront. This may make financial advice only available to the wealthy and exclude the less well-off.
Advisers whose client bases include the less well-off may be forced to leave the industry. A report in July 2011 by Aviva claimed that up to 3m people could struggle to find good quality guidance as advisers drop lower-income clients. Meanwhile, advisers without the necessary qualifications now have less than 11 months to gain it. Industry participants fear this may lead to a wave of early retirement among advisers. Financial institutions are cutting levels of advisers.
A further side-effect of RDR will be the growth in sales of investments that can be sold without advice, or “execution-only” business. It means a potential boost for a fast-growing section of the investment market known as Exchange Traded Funds (ETFs), which can be sold without advice. But this does not necessarily mean it is in the public’s interest if they don’t fully understand what they’re buying.
It is hard to argue that investors do not need more protection—but the RDR might have precisely the opposite effect. We should not lose sight of the fact that any market-based investment always contains some risk; the important thing is to educate investors about what markets do without frightening them away from the need to save for their long-term wealth.
