The chief of the IMA has debunked critics' claims of 'hidden' charges, but has done nothing to say if funds are too expensive.
by Gavin Lumsden on Jan 27, 2012 at 17:23
Article from City Wire Money
Richard Saunders, chief executive of the Investment Management Association (IMA), has fought back in the debate over ‘hidden’ fund charges, denying claims they cost investors billions of pounds a year.
The IMA, which represents most UK-based investment companies, has provided new figures (see table below) which it says prove that trading costs are not the big problem some critics make out.
Battle over charges
At issue is how fund managers disclose their charges to investors, and how far these expenses reduce returns to investors.
Typically, fund managers quote an annual management charge, which, in the case of actively run unit trusts investing in shares, is around 1.5%. This does not give the whole picture though, and there is a growing awareness that a total expense ratio (TER) – which includes additional costs such as custody, trustee and auditor fees – is a better measure. TERs range between 1.8% and 2.8%, which can be a real drag on performance given falling interest rates and rocky stockmarkets over the past 10 years.
However, critics claim that TERs are themselves incomplete in that they do not take into account the 'hidden' trading costs incurred by fund managers. They want fund groups to formally disclose the impact of 'spreads' (that is, the 5-6% gap that exists between the entry and exit price of unit trusts) and the level of turnover (or number of stocks bought and sold) within the fund.
It is this 'myth' the IMA has challenged, saying that average trading costs for actively managed funds are 0.31% a year, and just 0.06% for funds tracking a stock market index such as the FTSE 100.
Critics' 'charges do not add up'
The IMA's table shows that the difference between average fund returns and stockmarket returns over 10 years is less than the average TER. The only conclusion, it argues, is there can be no hidden costs.
Saunders (pictured) said: ‘People need to save for the long term. They do not need to be scared off by false stories that if they do so they will be ripped off by the industry. The IMA’s figures demonstrate clearly that so-called hidden charges which cost investors billions a year are a complete myth. If the accusation were true, it would show up in the net returns achieved by investors. But there is no sign of it. The accusations of hidden charges do not stand up.’
He also said the trading costs were disclosed in funds' annual reports.
Not the whole story
Saunders makes a good case for his members, although it is worth noting the IMA's figures are based on the 129 larger funds in the UK All Companies sector. This is often used as a benchmark for the whole investment industry, although of course it is just one portion of it.
According to our UK All Companies league table there are in fact 169 funds with a 10-year record in the UK All Companies sector. Smaller funds tend to have higher TERs (same fixed costs but bigger proportion of smaller amount of assets).
Including all of these in its analysis would have produced a slightly worse result for the IMA. Extending the analysis to all IMA member funds (there are at least 1,500) would have changed the result again as transaction costs in emerging markets and other overseas or specialist areas tend to be much higher.
Are funds too expensive?
The real point is whether fund charges are too high. I believe they are. Unit trust annual management charges have stood at around 1.5% (for actively run funds) for as long as I can remember. They have not come down despite competition from low-cost tracker funds or the advent of the Internet age. The main obstacle has been the cost of selling funds through independent financial advisers (IFAs) and the lack of transparency in charges.
My hope is that the Financial Services Authority (FSA)'s plans to abolish the payment of commission to IFAs at the end of this year and introduce new rules for online investment platforms like Hargreaves Lansdown will herald big changes.
Hargreaves' introduction of a monthly tracker fee before Christmas was widely seen as a negative. However, it could be a precursor to far more transparency in which investors get to clearly see how much they pay for the platform and how much they pay to the fund manager.
Active funds – how many are worth it?
In that context fund manager charges could well fall. But will they plunge? In some cases yes, but that depends on performance. Although investors should be cost-conscious, there is no denying that if a fund manager generates above-average returns it's probably worth paying above-average fees. Our list of Citywire rated fund managers helps identify some of these.
That said, the IMA figures are a huge challenge to active fund managers and a reminder to investors to be realistic about the returns they should expect. After all, an average annual return of around 4% from a decade investing in UK stock market funds is not much to shout about, although at least it is a positive return.
More importantly, the table shows the average active unit trust achieved an annual return of just over 4%, only 0.17% more than the average tracker of the FTSE All Share. Given the charges of the former will be at least double those of the latter, it is clear that many active fund managers still have to prove their case.
That could be the real legacy of the IMA's announcement.
Article from City Wire Money
