As high costs come under scrutiny we break down the typical fees.
More than meets the eye to fund charges
The Telegraph's revelation that we pay an extortionate amount in fund fees – about £7.3 billion every year – piles on the misery for British savers grappling with jittery stock markets and low returns.
When shares are soaring, little attention is paid to the amount in fees that investment companies rake in. But when fund values are falling, the costs paid by investors account for a greater proportion of their total returns – and it gets noticed.
"Now we have consistently low inflation, charges represent a far higher proportion of any investment return than in years gone by," says Clive Waller at CWC Research, the financial analyst. "Charges matter."
Understandably, companies need to levy charges to cover their costs and return a profit. Even something as simple as sending out a policy statement costs money, particularly when they have tens of thousands of investors on their books.
Then there is the cost to the company of paying commission to salesmen and independent advisers. These are generally funded by customers, regardless of whether they buy direct from the fund management group or through an independent financial adviser.
Tom Stevenson, investment director at Fidelity, says: "Our portfolio managers are supported by hundreds of analysts, meeting companies, talking to their suppliers and customers and scouring balance sheets for the information that can give our clients an investment edge. This is a costly but, we believe, essential activity and it is reasonable that this should be reflected in the annual management charges of our funds."
But investors should check to see what they are being charged. If, as many experts predict, we are in for several years of subdued investment performance, it is important to look at more than just the annual management charge.
There is a raft of additional charges on both unit trusts and open-ended investment companies (Oeics). These include audit fees, dealing costs and servicing charges.
What is the annual management charge (AMC)?
This is the figure that is published on the fact sheet and is the fee that most savers – incorrectly – understand to be the amount they pay each year for the fund manager to run the fund.
Taking the typical AMC of 1.5 per cent, about two thirds of this is used to pay for research, wages and costs associated with physically managing the money within the fund. The remaining 0.5 per cent is paid out as "trail commission" to independent financial advisers or the fund provider each year for so-called "servicing costs".
Trail commission is a controversial charge. Critics argue that many advisers get this annual fee for doing next to nothing and question whether many deserve the remuneration, given that they do little to encourage their clients to switch out of perennial poor performing funds.
But the AMC doesn't tell the whole story on fund fees and charges – there is also the TER.
I've never heard of the TER. What does it stand for?
For a better idea of the cost of your fund, you should look out for the total expense ratio (TER). Unfortunately, investment fund companies are not obliged to reveal TERs and many will publish only the annual management fee, leaving investors with the mistaken impression that this is all they have to pay. It is not.
The TER takes into account dealing costs, stamp duty and auditors' fees as well as the annual management charge. You can often find TERs of more than 150 basis points above the annual management charge. Take Threadneedle Managed Income, for instance. Its AMC is just 0.25 per cent, which you may be mistaken in thinking is a bargain. However, the fund's TER is 1.77 cent.
So does the TER include all the costs that I pay?
I'm afraid not. The TER does not include the trading costs – the costs for buying and selling shares within the fund. The more active a manager is in trading the underlying portfolio, the higher these costs.
That said, investors have to expect some extra cost here: after all, you would be seething if your manager just sat on his backside all year. On average, trading costs can add another 1 per cent to your annual fees but some argue that managers buy and sell shares simply to rake in this extra revenue.
A higher TER will obviously cause a drag on performance. For example, a £7,200 fund investment growing by 7 per cent each year will reach £14,163 after 10 years, before charges. A fund levying an annual TER of 1.55 per cent would be worth £12,240 after 10 years, but a fund with a TER of 2.25 per cent would be worth be £788 less, at £11,452, according to Lipper, the fund analysts.
Can I compare the true costs of investing in different funds?
No. Trading costs range from about 0.09 per cent a year to one per cent. "The AMC is a quite useless figure; the TER is misleading because it is not total – it does not include dealing charges or, if it's a fund of funds, the charges on the underlying funds," says Mr Waller. "If the buyer knows exactly what the true cost is, he can compare fund manager performance against charges and make an informed decision."
How do fund charges vary?
Charges vary according to the type of fund and what it invests in. The fees levied on specialist funds, such as those investing in smaller companies, will almost certainly be a lot higher than those for funds that simply track indices, so-called tracker funds.
For example, the average UK equity fund has a TER of 1.6 per cent compared with the average corporate bond fund's TER of 1.15 per cent. Actively managed funds cost more to run than trackers because the latter are effectively managed by computer programs while the former incur the costs of researching individual stocks.
Mr Stevenson says: "Simplistic comparisons between the charges levied on actively managed funds and index-tracking or passive funds miss the point. The two investment approaches incur different levels of cost, so the question is not whether stock-picking funds should be more expensive than trackers (they are) but whether their higher charges are transparent and a fair reflection of the extra resources and effort involved."
So are cheaper funds better?
Not necessarily. It is fair to say that the lion's share of funds underperform time after time and many do not offer value for money.
The fund groups that charge the most argue that investors are better off paying extra for decent performance. However, a significant number of funds fail to deliver consistent above-average performance year in, year out, and if you are paying a high TER for dismal performance it is time for a rethink.
It is clearly worth paying a higher TER for consistent outperformance and a high TER does sometimes pay. Take Jupiter Merlin Balanced Portfolio. This popular selling fund has a TER of 2.3 per cent, which is higher than the average – yet it outperforms its peers regularly and is justifiably recommended by many investment advisers.
http://www.telegraph.co.uk/finance/personalfinance/investing/7923367/More-than-meets-the-eye-to-fund-charges.html
http://www.telegraph.co.uk/finance/personalfinance/investing/7923367/More-than-meets-the-eye-to-fund-charges.html
