Everybody is talking about fees these days. The retail distribution review has brought about a renewed focus on charging structures at both the fund provider and adviser level.
The IMA is encouraging providers to produce standard documents setting out the breakdown of the charges that investors pay.
Fund providers are responding to this increased scrutiny by launching new lower-cost share classes and, in some cases, adopting new, all-in pricing models.
I welcome these moves. However, they do prompt a few important questions:
• Will transparency on costs become the norm from fund providers?
• Do investors appreciate the importance of costs?
• Do they even understand the terms that we use?
• Does it matter?
Fund providers have been busy launching new ‘clean’ and ‘super clean’ share classes, many of which have lower AMCs than previous offerings. But can advisers be confident that the AMCs on these new share classes capture all of the charges investors pay when they choose the funds? In other words, does AMC = TER? A lower AMC often looks cheaper at first glance, but there may be other charges that are not included in that headline figure. It is not always clear.
That is not to say the industry will never get there, of course. The IMA and the FCA are both in favour of improved cost transparency. But as an industry we are not in a “new normal” environment of total transparency just yet. Most investors know that it is a good thing to put money to work for the future – that is why they invest. With the help of their advisers, many appreciate the difference between a desired return, which can lead to maximising performance with little heed for risk tolerance, and a required return, by which we mean the return they need to generate in order to achieve their goals.
When you are constructing portfolios to help your investors reach their goals, costs play a central role. In a world where your fees, and the fees attached to the funds you recommend, are increasingly transparent, it makes sense to tie your value proposition to things you can control. And costs are one of the very few things you can control.
Figure 1: The long-term impact of costs
Source: Vanguard Asset Management.
This hypothetical example assumes an investment of £100,000 over 30 years. Annual compounding is used for both the assumption of 6 per cent average growth a year and the investment costs. Costs are applied to average annual growth of 6 per cent for each year. The costs shown reflect the average TER of an active fund (1.33 per cent) and a passive fund (0.33 per cent) in the UK as at the end of December 2013. As it is a hypothetical, this example does not represent any particular investment.
You can help your clients understand the importance of costs using a couple of simple statements. The first is that investing is different to other industries because here, you get what you do not pay for. That is because every pound your clients pay in fund charges is a pound that will not be put to work in pursuit of their goals. And the second is that, if they understand the concept of compound interest, they should think about the idea of compounding costs.
