InvestmentsMay 18 2016

Lifting the lid on fund fees

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by

The contentious topic of fee transparency is back in the news following the revelation that star fund manager Neil Woodford is to absorb the research cost into his flagship fund and not pass it on to investors.

The move will see the investment company foot the levy which accounts to a mere 0.02 per cent of the £8bn CF Woodford Equity Income Fund. For an individual investor with £50,000 of assets invested in the fund, the fee would amount to £10.

While the initiative will not have dramatic financial implications for individual investors, it is likely to have greater ramifications on the wider UK and European fund management industry – which will see the introduction of more red tape over how managers disclose charges to customers.

The fund house has also published a breakdown of all the fees associated with the income fund on a single page on its website – with plans to update the figures each month on a rolling 12-month basis.

Mr Woodford’s fund follows in the footsteps of a small number of its peers who have taken steps towards greater transparency and simplicity including: Baillie Gifford, LGIM, Invesco, First State.

Investment banks are racing to get their research divisions and fees in order in advance of MiFID II regulations due to come into force in 2018 – which will reshape the governance and costs and charges disclosure of funds.

Gina Miller, a campaigner on fund managers’ fees and founding partner of wealth boutique SCM Private, said: “If you look at their actions, rather than their [industry] associations’ slick words and worthless codes, the evidence points to them having little or no appetite for genuine reform.

“They say they are client focused, putting clients first but continue to deny clients the basic consumer right of knowing exactly how much they are paying.”

A 2014 White paper by Professor David Blake, director of the Pension Institute at Cass Business School, suggested that concealed costs – such as bid-ask spreads and transaction costs in underlying funds – can make up to 85 per cent of a fund’s total transaction costs.

“The FCA has been guilty of lacking backbone and deferring their responsibilities to the industry trade body.” Gina Miller

Speaking to Financial Adviser, the professor said the majority of investors are clueless about the fees that contribute to the overall cost of a fund, and that by unbundling them, they would be reticent in paying some of the levies.

“They [fund charges] are incredibly confusing for the investor. Investment companies implement different charging models. TER, OCF and AMC. Why the industry can’t agree on the definition of something as simply as the annual management charge (AMC) is really quite remarkable.”

“Having MiFID II is useless unless you get these investment companies to agree on what cost should be included within the overall fund charge and the definition of turnover cost.”

The importance of establishing a uniform fund charging model is perhaps most pertinent when it comes to choosing funds, if the latest Morningstar research is anything to go by.

The study which examined US open-ended and exchange-traded funds to evaluate the predictive nature of fund expenses on future total returns, load-adjusted returns, standard deviation, investor returns concluded that fund fees are a “strong and dependable” predictor of future success.

Russel Kinnel, chair of Morningstar’s North America ratings committee, who authored the study, entitled Predictive Power of Fees: Why Mutual Fund Fees Are So Important, said: “We found that the cheapest funds were at least two to three times more likely to succeed than the priciest funds.

“Strikingly, our finding held across virtually every asset class and time period we examined, which clearly indicates that investors should keep cost in mind no matter what type of fund they are considering.”

Prior to the RDR, fund managers levied a single annual management charge on their funds - incorporating the cost of managing the investments, platform services and trial commission payment to a financial adviser as well as ‘back of office’ fee which included legal and administrative costs.

According to FCA estimations, the UK investment managers paid £3bn of dealing commissions per year to brokers, with around £1.5bn of this spent on research.

The FSA banned commission on retail investment products under the RDR from 1 January 2013, and legacy payments on existing business on platforms came to an end in April this year.

Fund houses have since unravelled their single charging structure to offer ‘clean share classes’ which excludes the payment made to an investment service as part of its AMC.

In 2014, the FCA called on investment firms to scrap the AMC on funds in favour of the ongoing charges figure model following its review of the marketing information made available to UK retail consumers by 11 investment firms.

However, Ms Miller panned the city watchdog for not doing enough to tackle the issue of fund fee transparency.

She said: “It is a travesty that a report commissioned by the FSA in 2000 found that as much as 50 per cent of investment costs were being hidden, and that we are still debating this issue today, 16 years later.

“To be ignorant of the facts is one thing, to have the knowledge but refuse to act is nothing short of shameful. The FCA has been guilty of lacking backbone and deferring their responsibilities to the industry trade body.

The Investment Association has long pushed for greater clarity and consistency for customers when it comes to fund charges but it has been stifled in its attempts to push through a reform agenda by threats of exit from key members of the trade body, according to Mr Blake.

Darius McDermott, managing director at Chelsea Financial Services, said further unbundling could have the opposite effect and increase the cost of investing as providers pass the cost of transparency onto consumers.

He added: “What Woodford is doing is admirable but it is a new company. It is much easier to administer transparency when you have only two funds, but it is harder to do for an investment company with 50 or 60 funds.”

Myron Jobson is a features writer of Financial Adviser

Key Points

Star fund manager Neil Woodford will absorb the cost of research into his flagship fund.

Having MiFID II is useless unless you get these investment companies to agree on what cost should be included.

In 2014, the FCA called on investment firms to scrap the annual management charges on funds in favour of the ongoing charges figure model.