The fees charged by active managers have tended to trend downwards over recent years, following moves such as the unbundling of share classes under RDR and demands for low-cost solutions, but many investors still make a point of shunning the highest charging funds.
Leaving the active versus passive debate to one side, investing in products with lower fees is not a bad approach to follow. Higher fees do detract from overall returns and the compounding effect of this means elevated charges can lead to a significant difference in outcomes for investors.
Fees have jumped back into the headlines this week after research by Cass Business School argued for an overhaul of the charging models used by asset managers while the Financial Services Consumer Panel (FSCP) called for urgent change in how costs are passed on to investors.
Cass Business School’s Heads we win, tails you lose paper, written by professors Andrew Clare, Nick Motson, Richard Payne and Steve Thomas of the Centre for Asset Management Research, said fund managers should look at adopting fee structures that better align investors’ and managers’ interests.
Three types of fee structure were analysed by the research: fixed fees, which is the conventional method where charges are a proportion of assets under management (AUM); asymmetric fees, which have a base charge linked to AUM plus a performance fee on outperformance; and symmetric fees, where the performance fee is linked to both over- and underperformance.
Using ‘Monte Carlo’ statistical techniques, the researchers ran thousands of simulations to see how investors in managers with varying degrees of skill fared under the three different charging models.
While none perfectly aligned managers’ interests with those of the investor, the findings suggested that the current model is not the best for investors.
Professor Payne said: “The study identifies a clear incentive mismatch between the best interests of investors and managers. More specifically, there is no single structure that simultaneously maximises both the investors’ and the managers’ satisfaction.”
“In fact, our results show that the most prevalent fee structure currently in the UK market – a fixed fee as a proportion of AUM – is generally the best structure for the manager and the worst for the investor.”
However, the study found that symmetric performance fee structures would be the most attractive for investors. Under these models, the asset manager charges a base fee and gains a performance fee when it beats the index by a set margin, but has to reduce fees when it underperforms.
The ability to charge the base fee means the manager is not fully aligned with the investor – as the manager still receives some of their fee even if they lose money – but this structure would make underperformance ‘painful’ for the fund manager as well as their clients.
Professor Clare added: “It’s about time there was a serious debate about fund management fee structures. Our results show that a symmetric fee structure is, on the whole, in the best interest of investors. How long can an industry ignore the best interests of its customers?”
Today also saw the publication of a discussion paper on the cost of investing in retail funds by the FSCP, which is an independent statutory body established to represent the interests of consumers in the development of policy for the regulation of financial services.
The group says it wants “radical reform” of the investment management industry after arguing that most retail investors do not know what they will actually pay out in fees. The paper suggests headline figures such as annual management charges show as little as one-quarter of a fund’s true costs because many are essentially hidden as they are deducted directly.
Sue Lewis, the chair of the FSCP, said: “The problems our research has identified are longstanding, and need fixing urgently. People are depending more and more on investment to deliver their long-term financial wellbeing, especially in the light of the recent pension reforms.”
“It is completely unacceptable that consumers do not know what firms are charging them to manage money on their behalf, and cannot compare different offers. While we recognise that the industry is working to improve disclosure, this does not go far enough.”
The panel suggests that asset management firms should be required to quote a single and comprehensive annual charge, which would include estimates of variable forward costs such as transaction charges. This would allow funds’ costs to be compared more accurately, it argues.
Any other costs which are currently borne by the fund would be paid by the asset manager, which the group claims would create a “powerful incentive” for them to improve efficiency.
The suggestions have won some support from members of the industry that have been campaigning for lower fees and improved transparency.
Gina Miller, founder of SCM Direct and the True and Fair Campaign, says the FSCP’s report should act as a “wake-up shout” for the fund management industry and its regulators.
“For three years, we have been calling for the investment management industry to give total transparency on all costs and fees, and to disclose all costs in a single number, in pounds and pence,” she said.
“The industry has treated our calls with contempt and aggression, despite the fact that our consumer research has consistently shown that consumers want clarity and total transparency on costs and fees.”
Meanwhile, Nutmeg chief executive Nick Hungerford says he “thoroughly” welcomes the changes proposed by FSCP.
“It’s disgusting that consumers have so little chance of knowing the true cost of their investing activities and it’s high time every business was forced to make all investment fees crystal clear,” he said.
“We must collectively strive for a healthy, competitive retail environment, in which there is complete transparency and fairness to customers. Investment fees are at the sharp end of that challenge. Too many businesses think they can shove everything in the small print, surround it with confusing jargon and still label their actions as ‘transparent’.”
