EU puts fees under the spotlight

They usually have a variety of components which typically include one or all of the following: an ad valorem management fee, transaction charges, a compliance charge, custody charges, and an extra charge for managing Isas.

Other sources of income include revenues from in-house funds held in client portfolios and interest earned on client cash, as this is very rarely credited in full – even at today’s low interest rates it is surprising how much revenue is generated from this source.

Given the above it is very difficult to calculate the actual annual cost of managing one’s portfolio. However, it is not uncommon for these ancillary charges to account for the same or even a little more than the headline ad valorem charge. This is especially the case for smaller portfolios where the impact of these typically fixed costs are higher.

However, things are about to change as new European-wide legislation (Mifid II), currently scheduled to come into force on January 3 2017, will require managers to disclose every year the total costs involved in managing a portfolio, including the cost of third-party management. The approach of this deadline is resulting in a growing number of managers introducing clean fee structures where one, all-inclusive fee is levied.

However, in many instances these are not as clean as they profess to be, as very few managers pay interest on cash in full and fully offset the underlying charges on in-house funds.

Although fees are clearly an issue for the private-client industry, it is probably not as large a one as people think, because if one analyses the reports and accounts of the quoted sector, the aggregate fee-take, including all ancillary charges, ranges between 0.8 per cent and 1.5 per cent a year of their assets under management.

These figures give a rather more accurate idea of the costs a client can expect to pay, although one hastens to add not the full picture, as smaller clients tend to pay a considerably higher rate than larger clients. Whilst 0.8 per cent seems a reasonable figure, 1.5 per cent looks on the high side, and once full disclosure of the annual costs is mandatory these firms are likely to see a sharp drop in business.

The move to clean fees is not the only trend that is taking place, as we are seeing some managers offering performance fees and/or fixed fee options, as well as the standard ad valorem charge.

Performance fees are popular with clients and advisers as they are seen as aligning the interests of the manager and the client more fully. However, if the manager exceeds their specific performance target these fees may well be significantly more expensive than other options.

Fixed fees that rise annually in line with inflation are perhaps the best option for clients as, assuming that investment returns are higher than inflation, the fee paid will fall as a percentage over time.

However, ironically these are not as popular because the fee charged goes up even if there is a fall in value of the portfolio.

Alan Beaney is investment director at RC Brown