Clear investment costs should lead to clear understanding

With the retail distribution review focusing on client outcomes and transparent charging structures, everything from adviser to provider and fund manager fees has come under increased scrutiny. One remaining area less scrutinised is that of outsourced portfolio services, such as provider-led managed portfolio services or discretionary fund managers.

It’s an area we’ve looked at in some detail in a recent report comparing the price of portfolio services (see the Skandia website for details). We used independent data from the lang cat, a consultancy that is exemplary at getting under the bonnet of complex propositions and finding out what’s going on and what it all costs – and they found it a very painful process indeed. It struck me that if they found it hard, most advisers and certainly almost all customers would too.

The report called for a greater focus on the total cost of investment and found striking cost differentials. At the top end of the scale the difference between the cheapest and most expensive total cost of ownership of a pension portfolio with £500,000 invested over ten years was £46,000. As total cost – including platform, advice, investments and portfolio management – becomes clearer, even greater scrutiny will be placed on the component parts and the value they offer. Everyone in the chain has to prove their worth.

Of course, value for money is subjective, but when it comes to investing in actively managed funds it should be considered more straightforward. Simply put, if a fund outperforms an equivalent benchmark or meets specified criteria such as a risk or performance target over a defined period of time it is delivering value. The question remains,does the investor receive commensurate value for the additional costs of active management? Now, I’m no investment guru and I’m not going to attempt to delve into the finer points of value ratios and I suspect you would rather I didn’t. However, if we head down the well-trodden path of the ‘active vs. passive’ debate, we will end up at a similar juncture: is the reduced price of a passive investment better in the longer term than the opportunity of active outperformance?

As ever, assessing a single component of total cost in isolation is misguided and somewhat hazardous. For example, in comparing the total cost of similar portfolio management services for our report (see table), it became clear that investors could end up paying a similar or even greater total cost for portfolios with significant passive weightings compared to wholly active portfolios. To quote John Lappin in his regular Investment Adviser column, “offering providers access to active fund management at a comparable total expense ratio to portfolios that have much more passive exposure … is at least a small spanner in the works of the traditional passive case.”What’s more, it is difficult in some cases to actually ascertain the active and passive weightings.

Outsourced portfolio services are, on the whole, a force for good in an environment where advisers are putting much greater focus on the financial planning needs of their clients than the investment advice. However, it is clear that advisers should demand more information as the layers of charges build up as they seek to make choices that will provide the right outcome. It could be the case that some services are almost constrained to passive investments in order to reduce the total cost of investing over a period of time.

Furthermore, where active management is required it is equally important to ensure managers are selected who use a defined process and investment philosophy in an attempt to deliver outperformance to customers. Every fund selected for a customer’s portfolio needs to be fully researched and analysed to ensure it matches their appetite to risk and overall investment goals.

The right decision regarding wrapper selection, taxation and investment solution can make the difference between success and failure. As an industry we need to develop more solutions to help drive down costs. These must be outcome-focused, and aligned to the needs of customers. Our WealthSelect proposition was developed with all of this in mind. It enables advisers to offer high-quality portfolio management solutions to clients at very attractive prices.The research into the quality and suitability of funds has already been conducted to include managers who: have a proven ability to deliver strong performance; extensive industry experience; proven skills in a variety of market conditions; a strong understanding of the strengths and limitations of their approach and a long term investment approach.

We hope that allowing advisers to access active funds that fit all of the above criteria, at highly competitive prices, offers compelling value. After all, if investors don’t have any exposure to active funds they will never have the opportunity to achieve above average returns, which is the ultimate aim of investing.