Today’s consumers are usually quite savvy about how much they pay for things - and quick to look elsewhere if they’re being taken for a ride. But far too many of us still have a blind spot when it comes to fund charges.
Quietly and automatically, fund management companies are deducting thousands of pounds from our long-term investments every year for often very meagre returns. As one commentator recently put it, drawing inspiration from Sir Winston Churchill, “Never has so much been taken by so few from so many, and for so little in return.”
There’s greater awareness of what’s going on in the US, where investors tend to take more of an interest in what they’re paying and the returns they’re making. There’s been a greater focus in the media there on value for money, and investors have a much a wider range of low-cost options to choose from.
In the UK, where fund charges are (according to one recent survey) 58% higher than in the States, we’ve got plenty of catching to do. Here, then, are six reasons why UK fund charges are a rip-off.
1. Charges are expressed as percentages
For the vast majority of goods and services, prices are quoted in pounds and pence. But fund management fees are always expressed as percentages. Furthermore, they’re percentages not of the contributions you make but of the total value of your fund. In percentage terms, annual management charges seem modest and reasonable. But if managers were made to give you a pounds-and-pence figure every time they siphoned money from your fund you’d be far more likely to sit up and take notice.
2. They compound over time
Compounding refers to when a fund generates returns, which are then re-invested and in turn generate their own earnings. But while compounding is the friend of the long-term investor, it is also the friend of the product provider. As your fund grows in size, so does the amount you’ll be charged. As research has shown, compounding means that just one percentage point in charges can make an eye-watering difference to the value of your investments over time.
3. They’re not all-inclusive
The figure you most often see quoted is the AMC, or Annual Management Charge. But this is just part of what you pay. It doesn’t, for example, include the platform fee or the adviser fee. Most importantly, it doesn’t include on-going transaction costs. Depending on how many times your fund manager buys and sells, these can add up considerably. There’s even evidence from the University of Oxford to suggest that some fund managers deliberately trade more often than they otherwise would simply to maintain their profit margins.
4. You don’t know what you’re paying for
Normally when you buy something, you’d expect to be told - or at least be able to find out - exactly what it is you’re buying. However, unlike in the US, where fund managers are legally obliged to be make details of their holdings public, there’s no requirement on UK managers to disclose how much is invested in what. Many fund managers are reluctant to provide information - possibly because, if they did, investors would realise they’re being charged for what are in effect “closet trackers” which should have lower charges. Research by the True & Fair Campaign suggests that about half of retail equity UK funds fall into this category.
5. Returns are, by definition, average
As much as fund management companies like to give the impression that they add value, the statistics tell a different story. Over time, markets deliver returns on their own. The only reason for recruiting an active fund manager is to deliver returns over and above the market. The fact is, though, that fund managers collectively are the market. Every manager claims to be able to outperform - you’d hardly expect them to say otherwise! - but, in a zero-sum game, there must be winner and a loser for every trade. One manager has to win at another manager’s expense. Yes, you might be lucky to pick the next winner, but you’re just as likely to choose a loser.
6. Win or lose, the manager gets paid
To add insult to injury, if you do pick a loser, the manager still wants remunerating. So you’re paying him a percentage of your fund in return for underperforming the market. If the market itself falls 10 or 20%, that’s just tough. And what if your manager does outperform? Well, be sure to check the small print, because you might just need to pay him a performance fee, in which case you’re effectively paying him twice. Yes, that’s right, you the investor provide all the capital, and you take on all the risk. But your fund manager gets handsomely paid, year after year - regardless of how he performs or what the markets do!
If all this has left you wondering why you’ve been paying so much for so little for so long, the good news is that here are plenty of better, cheaper alternatives out there. By investing in a low-cost fund that simply captures the returns of an entire market, you can ensure that, after costs, you will be one of the winners.
You need a very good reason for turning down a proposition like that. What’s yours?