Everybody is talking about fees these days. The retail distribution review has brought about a renewed focus on charging structures at both the fund provider and adviser level.
The IMA is encouraging providers to produce standard documents setting out the breakdown of the charges that investors pay.
Fund providers are responding to this increased scrutiny by launching new lower-cost share classes and, in some cases, adopting new, all-in pricing models.
I welcome these moves. However, they do prompt a few important questions:
• Will transparency on costs become the norm from fund providers?
• Do investors appreciate the importance of costs?
• Do they even understand the terms that we use?
• Does it matter?
Fund providers have been busy launching new ‘clean’ and ‘super clean’ share classes, many of which have lower AMCs than previous offerings. But can advisers be confident that the AMCs on these new share classes capture all of the charges investors pay when they choose the funds? In other words, does AMC = TER? A lower AMC often looks cheaper at first glance, but there may be other charges that are not included in that headline figure. It is not always clear.
That is not to say the industry will never get there, of course. The IMA and the FCA are both in favour of improved cost transparency. But as an industry we are not in a “new normal” environment of total transparency just yet. Most investors know that it is a good thing to put money to work for the future – that is why they invest. With the help of their advisers, many appreciate the difference between a desired return, which can lead to maximising performance with little heed for risk tolerance, and a required return, by which we mean the return they need to generate in order to achieve their goals.
When you are constructing portfolios to help your investors reach their goals, costs play a central role. In a world where your fees, and the fees attached to the funds you recommend, are increasingly transparent, it makes sense to tie your value proposition to things you can control. And costs are one of the very few things you can control.
Figure 1: The long-term impact of costs
Source: Vanguard Asset Management.
This hypothetical example assumes an investment of £100,000 over 30 years. Annual compounding is used for both the assumption of 6 per cent average growth a year and the investment costs. Costs are applied to average annual growth of 6 per cent for each year. The costs shown reflect the average TER of an active fund (1.33 per cent) and a passive fund (0.33 per cent) in the UK as at the end of December 2013. As it is a hypothetical, this example does not represent any particular investment.
You can help your clients understand the importance of costs using a couple of simple statements. The first is that investing is different to other industries because here, you get what you do not pay for. That is because every pound your clients pay in fund charges is a pound that will not be put to work in pursuit of their goals. And the second is that, if they understand the concept of compound interest, they should think about the idea of compounding costs.
Marginally higher costs accumulate over the long term, as shown in figure 1. This can be the difference between reaching their goals and falling short. Put in these terms, the importance of costs becomes crystal clear.
With fee transparency likely to remain at the forefront of industry developments over the coming years, I expect investors and their advisers to favour companies with a reputation for plain talk when it comes to charges. However, until now the investment industry has not exactly made it easy for investors to get to grips with the matter. Indeed, given the history of fund char
Investing is different to other industries because here, you get what you do not pay for.For example, research conducted with 2,000 adults between 18 and 55 years of age found that just 6 per cent of respondents understood the meaning of the terms annual management charge and total expense ratio. Does this mean that 94 per cent of investors have no understanding of costs? Of course it does not, but when you add ongoing charges figures, fund manager fees and other three-letter acronyms into the blender, it is a wonder that we even managed to get to a figure of 6 per cent.
The research on investors’ understanding of industry jargon around costs raises an important point. If we want to encourage the next generation of investors, it is not good enough just to have low costs. We need to make charges as low as possible and as meaningful as possible. And, on top of that, we need to deliver simple, high quality products and a level of service that represents real value at the price that we charge.
If investors do not know what they are paying, it is hard to make an informed choice and, if they cannot make an informed choice, it is all too easy to take the easy option and defer the decision until tomorrow. To build a successful and sustainable industry that systematically helps investors to reach their goals, costs need to be low and clear and investors need to be confident that they are getting good value for money. The days of opaque charging structures are gone and advisers who have fully embraced the spirit of RDR know this.
Most of this article has been about fund charges, but of course that is only part of the equation: investors also have to pay for the advice they receive. For any advisers who fear the conversation about fees, we have some good news.
Research suggests that discussing fees can help foster a high level of perceived adviser value. As figure 2 shows, 57 per cent of clients who perceive a high level of value from their adviser have had a detailed discussion about adviser fees. Conversely, investors perceiving lower adviser value are less likely to have had a conversation about fees.
Figure 2: Fee transparency and adviser value
Source: Adviser Impact
So it seems that clarity on costs is in everyone’s interest. It helps fund providers because it is a stepping stone towards building a sustainable investing culture; it helps advisers because it is part of a clear value proposition; and, most importantly, it helps investors to make informed choices.
Nick Blake is head of retail at Vanguard Asset Management
Key Points
* Providers have been urged by the IMA to produce standard documents setting out the breakdown of the charges that investors pay
* When advisers are constructing portfolios to help investors reach their goals, costs play a central role
* If investors do not know what they are paying, it is hard to make an informed choice
