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July 12, 2013 5:43 pm

The hidden costs of investing

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Glacier viewed from above and below water©Corbis

Picture the scene. You’ve splashed out on the latest Aston Martin. But as you climb into the driver’s seat you’re asked to pay a fee for the key to the car and another charge for its manual. Then, just as you’re about to drive off the dealer’s forecourt you’re hit with yet more charges – an exit fee for leaving the garage, followed by separate charges for the leather seats and passenger door.

Most of us wouldn’t keep silent if this scenario happened in real life, so why do so few investors complain about the percentage of their money that goes on charges?

Click to see graphic on the real cost of investing

“Confusion about charges on investment funds and pensions has left most investors in the dark about how much they are paying,” says Gina Miller of SCM Private, a wealth manager, who is spearheading a “True & Fair Campaign” to encourage better disclosure of investing costs.

“This has suited the UK industry, which has benefited from charges that are among the highest in the world, but a decade of low returns has started to focus people’s attention on fees.”

Figures compiled for the Financial Times, using the campaign’s True and Fair Calculator reveal that the total cost of investing be more than twice the advertised annual management charge (AMC).

For example, in the Investment Management Association’s absolute return sector, the City Financial UK Equity fund cites an AMC of 1.5 per cent per annum. However, once ongoing charges, underlying trading costs and performance fees are added (assuming the fund returned 5 per cent a year) the total cost for the investor rises to 5.57 per cent a year.

The JPM UK Dynamic fund, which sits in the all companies sector, reports an AMC of 1.59 per cent but ongoing charges and trading costs push the total cost of investing, according to the True and Fair Calculator, up to 3.27 per cent.

“When you buy an investment fund you might think the manager’s initial charge and AMC are the end of the story. But other charges can apply,” says Justin Modray, founder of, an investment advisory service.

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“Initial charges of 5 per cent or more are a lot less common nowadays, but most unit trusts still suffer a bid-offer spread, a difference between the buying and selling prices. This covers the cost of creating or cancelling units, such as stamp duty, dealing fees and underlying investment spread which, in some cases could amount to 1 per cent or more.”

Other charges, such as custodian’s fees and auditors’ costs, also typically add an extra 0.2 per cent or more to a fund’s AMC, so check the total expense ration (TER), sometimes called the ongoing charges figure, which includes additional items.

However, even the TER isn’t comprehensive. Fund managers also incur dealing fees, stamp duty and possibly foreign exchange costs when buying and selling investments, but these are seldom explicitly disclosed. Their impact will depend on the fund’s “portfolio turnover” and the nature of the underlying assets. But some estimates put such costs at up to 3 per cent or more a year for some funds.

“Other potentially hidden costs include some exchange traded funds lending out stocks they hold and pocketing the income received themselves, rather than giving it back to investors,” said Mr Modray. “Also, with-profits investments levy unexpected market value reductions when some investors wish to sell, and older-style pensions apply excessive annual charges to early pension contributions over the whole life of the pension.” Many investment trusts still levy performance fees if they beat their benchmarks by more than a certain increment.

But things have improved lately, thanks partly to the ban on commissions to advisers and he growing tendency towards “clean” share classes, which don’t pay commissions to platforms. A Dianomi MarketViews survey conducted for the FT in January 2012 found that eight out of 10 private investors believed charges on managed funds were not being clearly disclosed to them – even though more than half said they considered “transparent fees” and “low dealing costs” to be the most important factor when buying funds.

The same survey, conducted last week for the FT by Dianomi MarketViews found investors were less disillusioned – this time six out of 10 believed charges were not clearly disclosed.

It seems recent pressure from the government, MPs and financial advisers now means that after decades of denial, investment and pension managers could be on the brink of making fees more transparent.

In April, Daniel Godfrey, chief executive of the Investment Management Association (IMA) put forward proposals for a further overhaul of how charges should be presented to investors. He outlined plans for a single figure to be displayed based on costs incurred in the past year. This would not, however, include charges levied by fund supermarkets, and entry or exit costs, and it would not be personalised to an investor’s holding period.

13 hidden fees
Fee Details
Custody fees For safe custody of financial assets, reporting and statements.
Management fees For providing ongoing investment advice.
Transaction fees A charge for buying or selling any financial security. Often called a commission charge.
Brokerage fees A charge for introducing a buyer to a seller in the buying or selling of a financial security. Again often called a commission charge.
The bid/ask spread The built in margin used by traders between the buy price and sell price of a financial security. Often called a mark-up.
Built-in product fees Hidden cost associated with structuring a product or fund.
Cash payment fees An administrative charge for transferring cash into or out of an investment account.
Active fund manager fees/ ETF fees Third party structuring and active management cost. Can also include additional administrative charge or upfront fees.
Administration fees For any non-investment related activity on an account.
Overdraft fees Borrowing cost and administrative charge as a spread over interest rates.
Trail fees Ongoing commission paid to third party introducers. Sometimes referred to as a retrocession or a rebate.
Jurisdictional fees Stamp duty in the UK or Switzerland when buying or selling a financial security. Withholding tax on capital gain or income.
Performance fees A percentage fee charged on any out performance relative to an agreed benchmark.
 Source: Yogi Dewan, chief executive and founder of Hassium Asset Management

But the investment industry still has a long way to go to encourage trust among investors, says John Kay, the economist who was commissioned by the government to look into the country’s equity markets. He blamed the long chain of intermediaries – including registrars, custodians, nominees, fund managers, trustees, investment consultants, platforms and independent financial advisers – for many of the problems. He said “some of this proliferation represents efficient specialisation – but most results from people looking over each other’s shoulders”.

Ms Miller agrees. She says the sheer length of the investment chain creates misalignment of interests as each intermediary pursues the goals of its own business. The outcome has been that over the past decade, individual companies have done OK, investment managers have done very well and investors have done badly, she says.

“When people were getting double-digit returns they didn’t care about how much they were paying in charges, but now performance has dwindled the impact of these charges is more worrying,” says Ms Miller.

Some fund managers justify the extra costs by producing top returns and Brian Dennehy managing director of says investors should focus on performance as well as charges (see box)

The Financial Conduct Authority (FCA) and its predecessor organisation has spent much of the past few years preparing for the retail distribution review, which aimed to raise the standard of advice given to UK investors by improving qualifications and banning commissions to advisers.

However, the FCA says that it is turning its attention to investment charges. “We are currently undertaking a project that will highlight the behaviour and practices of asset management firms in relation to charging structures in funds. These need to work in the interests of consumers.”


How charges can affect your pension

The impact of excessive costs upon investment performance is arguably at its most invidious in pensions. These tend to be long-term investments, so the impact of compounded costs is likely to be much greater. And there is substantial customer inertia; most people don’t check their pension plan very often and are largely unaware of the costs of running it.

Personal pension schemes, which were widely promoted in the 1990s, often have high annual management fees and some also came with steep initial charges. According to Hargreaves Lansdown, charges on the priciest 10-year personal pension plan on sale in 1992 ran to 4.96 per cent a year. There may also be fees for valuations and transferring between investment funds.

Over long periods, the impact of such charges can be dramatic, stripping thousands of pounds from the returns of even modest funds. Hargreaves Lansdown gives the example of a 35 year old earning £50,000 a year, saving the minimum 8 per cent of earnings specified under auto-enrolment. Just by cutting the charges on the pension fund from 1 per cent to 0.5 per cent, he could see his total pension fund increase from £271,000 at age 68 to £296,000.

However, Tom McPhail of Hargreaves Lansdown points out that it is also important to recognise that any savings on charges could involve compromises in terms of the investment management, the administration or the service delivered to the investor. “It may make sense to pay 1 per cent a year, if it means you are enjoying better investment management, or better quality service.”

He says many investors still have money tied up in high-cost plans, unaware that they are paying over the odds, but not enjoying the benefits.

Nor is the problem confined to personal pensions. Research by the Financial Times this year found that the performance of local authority pension schemes varied dramatically between one region and another, with costs often the deciding factor, while some workplace schemes have charged the cost of consultancy services direct to members’ pension funds, reducing long-term returns.

A big problem with the current pension system for investors, say experts, is that the charges on the majority of pensions funds are not as transparent as they could be, which has led to repeated calls for improved disclosure.


Performance is the key

For some years now the media and regulators have been obsessed by charges, writes Brian Dennehy, managing director of

The reality is that they have been fighting yesterday’s war – to be precise, a problem that was very real until the 1990s, when advisers introduced illustrations showing the impact of overall charges on growth, called the “reduction in yield calculation”. In my experience, there has been no clamour from clients for further clarity on charges since that time.

So, the sterile debate on charges needs to move on; fund performance is a significantly more important debate for investors. Perhaps an investor can shave a few tenths of a per cent off fund-related charges, but such savings pale by comparison to the extra growth that a straightforward fund selection strategy can generate.

What advisers, regulators and media should now concentrate on is improving investment outcomes for investors – be in no doubt, there is huge scope for improvement here.

Ironically, this will probably reduce charges for many investors anyway – advisers will be less inclined to recommend high charging funds of funds or discretionary fund management services, which also tend towards mediocre performance.


Investors confused by charges

FT poll: do you think charges on managed funds are clearly disclosed to investors

Most UK investors think investment charges are not clear enough, according to a poll of 1,260 active investors.

The Dianomi MarketViews survey, commissioned by FT Money, found that 56.2 per cent of investors thought charges should be made clearer. On managed funds, 62 per cent of investors thought there should be more transparency, compared to 38 per cent of people who said fees were clearly disclosed.

Of these active investors, 71 per cent also said they were considering investing in property. In terms of emerging markets, 31 per cent of investors said they were coming out of this sector, while 69 per cent they were putting money in.

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