Study finds advisers underestimate fund costs

Findings from a survey by Defaqto show advisers underestimate the total costs to their clients of all types of multi-asset solutions, as outlined in the chart opposite.

Part of the problem could be that nearly two-thirds of advisers (62 per cent) still use the total expense ratio (TER) measure of fees, in spite of it being less inclusive of costs than the ongoing charges figure (OCF).

A potentially worrying finding from the survey, which canvassed nearly 200 advisers, showed one in 10 did not know the difference between annual management charges (AMC), TERs or OCFs.

The lack of understanding could add weight to the Investment Association’s moves towards disclosure of fund fees in pounds and pence, which it hopes will make fees clearer.

The Defaqto survey was sponsored by Santander Asset Management and showed the cost of most routes to a multi-asset investment – whether it be a unitised fund, model portfolio or discretionary fund manager – were heavily underestimated.

“Given that the adviser fee is typically around 1 per cent per annum and a platform cost of around 0.3 per cent, it would appear that most investment solutions are much underestimated in terms of cost by around 1 per cent per year of total cost,” the report said.

The figures are a potential concern given the increased use of multi-asset solutions by advisers since the RDR, with another wave of interest possible with the pensions freedoms come April.

Defaqto’s survey showed two-thirds of adviser business is now directed towards multi-asset funds, including into unitised products or model portfolios. “The results compare against a similar survey Defaqto conducted in 2010, which indicated that advisers were slowly moving towards recommending their clients into outsourced multi-asset solutions,” it said.

In 2010, Defaqto found 46 per cent of advisers were constructing portfolios themselves, but this has now fallen to 24 per cent – 19 per cent using active funds and 5 per cent with passive funds.

The report said this was most likely due to the increased regulatory burden in the post-RDR environment. Advisers constructing their own multi-asset portfolios needed to “ensure they have selected a suitable strategic asset allocation for the client’s risk tolerances” and also measure themselves against a suitable benchmark.

“Our survey result showed that advisers who construct their own portfolios from single-asset active funds spend the most time on post-sale administration of their clients’ funds, at 5.5 hours per client,” the report said.

Conversely, 39 per cent said they used multi-asset funds in 2010 but now 33 per cent use risk-rated, multi-asset funds and 29 per cent use model portfolios accessed via a platform or directly from a discretionary fund manager. Together, this is far greater than the 2010 multi-asset number.

Tom Caddick, head of global multi-asset solutions at Santander Asset Management, said he thought advisers’ understanding of cost was “mixed” and there were “quite often broad misconceptions around embedded costs”.

“In an environment that we are moving into, which is theoretically one of low growth and low inflation, costs are arguably the single-biggest drag on investment returns moving forward,” he said.

Experts give their reactions to fund fee confusion

The ongoing charges figure (OCF) was meant to bring clarity to the charging regime prevalent in the fund industry.

Even though it does not include all costs associated with the fund – such as trading costs – it is far more inclusive than its predecessor, the total expense ratio (TER).

But there is still some confusion among advisers.

The Lang Cat’s Mark Polson said the Defaqto results echoed research it had previously carried out that showed advisers were “routinely unable to identify” full costs, excluding hidden charges.

“Many also clearly had annual management charges and TER/OCF mixed up,” he added.

Graham Bentley, who runs consultancy gbi2, said he was “not surprised” by the results of the survey. He pointed out the use of the OCF was “not being slavishly followed” by fund groups, who he said “still use the TER in presentations”.

“Most fund groups want their funds to look as inexpensive as possible and will do whatever they can within the rules to present their funds in the best light,” he said.

Mr Bentley praised the disclosure of fees on the Allianz RiskMaster range as good practice he hoped would soon be more widely followed.