It was back in 2011 that I left the general news beat and set my journalistic sights on the investment sector. What shocked me most about this industry as I began to look into it was how hard it was to work out exactly how much UK consumers pay to invest.
Amazing as it seems, five years later I still don’t know. Even financial professionals — advisers, consultants and journalists — who’ve worked in this field for far longer than I have are unable to put a figure on it. Many, frankly, don’t even have a clue.
I say I don’t know, but I’m getting closer to working it out, or at least working out who to go to for reliable information. For me, the person who has a better handle on this than anyone is Dr Christopher Sier, one of my fellow volunteers on the Transparency Task Force, who has been researching the cost of investing for many years.
In November 2011 Dr Sier produced a paper for HM Treasury entitled Complexity and Over Intermediation in UK Equity Fund Management. In it he calculated the total on-going cost to be a mind-blowing 3.1%, or in industry parlance, 310 basis points, per annum. That figure, he says, remains broadly accurate today.
Let’s put that in perspective. Between 1900 and 2001, the annual return on UK equities was around 4.5%. If investors really are paying 3.1% to intermediaries each and every year when the expected (not guaranteed, expected) market return is just 4.5%, that’s a truly extraordinary state of affairs. If, as some experts believe, market returns will be smaller in the future than they have been in the past, Dr Sier says we could soon, on average, see negative net returns.
So, how did Dr Sier arrive at that figure of 3.1%? Well, he says there are four main components to the cost of investing in UK equity funds. First there’s the annual management charge, or AMC, which is the cost you typically see advertised. The AMC, however, is just a small part of the total amount you pay. Secondly, there are explicit operational expenses. On average, added together, Dr Sier says these first two components come to 1.7%. On its own, 1.7% is enough to make a huge dent in your long-term investment returns, but we’re nowhere nearly finished yet.
The third component to the total cost of investing is the cost of trading. The fourth component is what Dr Sier refers to as “other costs”; indeed, a recent report by the Transparency Task Force claimed that investors are routinely hit with more than 100 additional fees and charges, many of them hidden. Added together, these last two components come to 1.4%, hence the total of 3.1%.
Why then, you might be thinking, have we not heard all this before? If it’s true that UK investors have, for decades, been handing over such a large proportion of their returns to intermediators, why wasn’t it plastered all over the newspapers years ago? Why hasn’t there been a campaign to give consumers a better deal? Why have the regulators not done something about it? Believe me, I’ve thought long and hard about all of those questions and I’m still struggling to find answers.
The good news is that progress is finally being made. In the United States, the financial media has taken a much tougher stance on the costs of financial intermediation in recent years. It frequently draws attention, for example, to the long-term impact of compounded fees, the dismal performance of actively managed funds and the conflicts of interest affecting brokers and advisers. In the UK, too, journalists are getting wise to what’s been going on. The Financial Times deserves special credit for leading the way in holding the industry to account.
The campaign for clarity on fees that the Transparency Task Force is now co-ordinating is starting to gain momentum. And yes, there are signs too that the regulator, The Financial Conduct Authority, finally intends to get tough with fund management companies that aren’t transparent. Along with the rest of the Task Force I eagerly await the FCA’s interim report on competition in UK asset management, which is due to be published in late summer.
There’s even evidence to suggest that, in anticipation of tougher guidelines, the industry has begun reviewing its fees. Yes, in some cases, fees are slowly coming down. Alas, the biggest fee reductions have been for passively managed funds, which were already very much cheaper than active funds. In fact, in many cases, fees have actually been going up. Stand by for more details on that in Part 2.
If you enjoyed this article or found it helpful, why not sign up to my email newsletter The Weekly Update?