All this week we are running a Guide to Active and Passive Investing to help you, the investor, make smart choices for your portfolio.
Tens of thousands of investors are paying excessive fees for fund management. Headline rates may look like they’ve come down – allowing asset managers to brag about reduced costs – but delve at little deeper and you’ll find that the cost of investment has risen significantly for many over the past two years.
Regulation introduced in January 2013 was designed to help investors understand exactly what they were paying for. The Retail Distribution Review stopped asset managers paying advisers commission, and a new clean share class was introduced for fund investors to access the underlying holdings without the additional cost of lining the advisers’ pocket.
As a result of this greater transparency the cost of investing as measured by the annual management charge (AMC) has fallen significantly. But other more opaque costs have rocketed, making it harder for investors to make smart choices – and benefit from any market gains.
Take admin fees for example. Five months ago I received a letter from Schroders alerting me to the “introduction of administration fee” on one of my ISA investments, the Silver Rated Schroder Recovery fund. The “application of the administration fee brings the A class units in line with the other unit classes issued by the Schroder Recovery Fund, where the 0.15% charge is already in place”. This is not the only fund Schroders have added an admin fee to. Investors can access an entire other equity market via a passive fund for incremental increase on this one active fund.
It contradicts a commitment Schroders made in March 2011 to low fees when they launched the Schroders Core UK Equity Fund at a cost of just 0.4% a year. Add to this the fact that the asset manager has bumped up the cost of all the old Cazenove funds it bought in 2013, despite having greater cost efficiencies of a larger firm and you can understand why investors may turn to cheaper passive funds in frustration.
Katherine Garrett-Cox, chief executive of Alliance Trust recently said that all too often active fund managers and their parent groups were too concerned about the fees flowing into their pockets rather than delivering the best possible result for the end investor.
“In 2013 the most popular funds on the platform were actively managed, last year there was a shift and the top selling funds are passive,” she said. “People have lost faith in active management in part because of fees. What you pay for a fund matters – it affects long term returns.”
Schroders aren’t alone in levying admin costs. A smattering of Jupiter funds have “other expenses” added to the AMC, bumping up the cost of investing by a sizable 0.3% a year.
A spokesperson for Jupiter said: “We believe if a fund manager is likely to produce outperformance over the long term after charges it is worth paying more for him or her. The evidence is that fund buyers continue to select funds on the basis of performance and cost rather than cost alone.”
Why the Increase in Cost?
A fundamental shift in the way we invest has caused asset managers to introduce extra fees to recoup lost revenues. Go back more than a decade and investors, particularly during the PEP and ISA boom years, bought funds directly from asset managers, and for each transaction there would be an annual or monthly admin fee of a few pounds. Now investors use investment platforms, which aggregate transactions – bundling together individual investors’ purchases as one. This means that where a fund manager may have had thousands of customers they now have just one – the platform.
The fund businesses were built up on these initial charges, and now rather than innovate, cut back-office staff and keep costs low, fund managers are scrambling to make up the difference.
Passives are Not the Only Cheap Funds
Legacy costs impact what investors pay today – and how much return on their capital they get. Take the comparison between Invesco Perpetual Income and Woodford Equity Income. While run by Neil Woodford IP Income had an almost identical portfolio to that of his new eponymous fund. But the cost of the IP fund is 1.66% - while you can buy Woodford Equity on Hargreaves Lansdown for just 0.6%. Invesco employs more than 750 investment professionals in 20 countries.
Woodford Funds has 30 people sitting in a business park in Oxford. Woodford outsources back-office and administration responsibilities to Capita, Invesco does not.
This is not the only example of cost disparity. Liontrust Macro UK Growth Fund charges 1.72%, while JOHCM UK Opportunities invests from a similar pool of equities and charges just 0.81%.
And it is not that the more expensive fund is offering a more impressive performance. Neil Woodford has outperformed Mark Barnett at IP over the past year, and the JO Hambro fund is Silver Rated by Morningstar analysts, where Liontrust Macro only earns a Bronze Rating. The old Cazenove funds are not performing significantly better now they have the Schroders moniker. That said, the better funds have all outperformed the market – something that a passive fund would never achieve.
This illustrates that while price is an important factor in determining how or where to invest, it is not the only consideration. Investors must be confident they are not paying more than they should be for active management, but also recognise that a fund manager that is able to deliver alpha throughout the market cycle is worth paying for.
