AMCs feel the heat
Fund management charges are coming under pressure in the retail sector. Paul Farrow investigates what that means for group pensions
Fund charges are in the spotlight - national newspapers have been cluttered with reports of fund managers charging excessive fees lately and the economic climate isn’t helping.
Dicey stock markets are lowering returns and so charges are coming under greater scrutiny. It goes without saying that Chelsea fans wouldn’t begrudge Fernando Torres his €175,000 a week if he never stopped scoring goals but that hasn’t happened. It’s the same with funds - investors and advisers wouldn’t moan about charges if funds outperformed and delivered decent returns consistently. But they haven’t, and competition from low-cost DC providers like Nest, Now: Pensions and B&CE is increasing pressure on charges, and the impending Retail Distribution Review has also raised awareness of how much a fund provider charges, how much a fund manager gets and how much the client gives to the adviser. It has also put fund platforms under scrutiny, with a handful of vocal City gents only too willing to stick the boot in.
Terry Smith, the maverick City veteran who runs Fundsmith, says: “I can’t think of another area of human economic activity where the internet has put an extra intermediary between the provider and the customer.
“Investors think fund platforms are saving them money. Really? That’s why fund managers can’t cut their fees. If a platform is taking 0.75 per cent off you - that’s what the big plat- forms are taking - it’s a bit difficult to charge only 1 per cent.”
So will the RDR herald a world where passive funds steal active fund managers thunder in the DC, Sipp and GPP arena? The Financial Services Authority wants to clear up the fund fee maze and under RDR it wants providers to disclose any fees or commissions for selling products. It also wants to ban cash rebates from fund providers to platforms. They are proposals that have courted controversy.
Fidelity has already announced that investors buying funds via its platform will be able to see how much the company gets paid by investment groups for selling them.
For example, investors will discover that if they buy the fashionable BlackRock Gold & General fund on Fidelity’s FundsNetwork, they will be charged an annual fee of 1.75 per cent, of which 0.875 per cent will go to Fidelity. If they decide to buy the popular Invesco Perpetual Corporate Bond fund, the annual management fee will be 1 per cent, with Fidelity getting 0.5 per cent. Fidelity will also disclose whether it will rebate a proportion of its fee to investors - a typical rebate is 0.15 per cent.
Investors will also get to see which are the most expensive funds and which are the cheapest.
A handful of funds charge a hefty 2 per cent and pay back 0.875 per cent to Fidelity. These include Gartmore UK Alpha, Henderson European Focus, Neptune Global Alpha, Prudential Global Growth Trust and three portfolio funds offered by Scottish Widows. The providers with the lowest annual charges on average are Santander (0.725 per cent), RBS (1 per cent) and HSBC (1 per cent).
But the industry is split on whether investors will care about being able to see the fee breakdown. Peter Hargreaves, who founded Hargreaves Lansdown, one of Britain’s biggest platform providers, recently said that customers didn’t care how much it was paid, they just wanted to know the total cost of investing. “The consumer wants to buy beans - they don’t care what margin the retailer has,” he added.
The FSA is currently minded to ban cash rebates and, in addition, platforms will not be allowed to receive payments from fund groups.
But this will does not stop unit rebates being paid directly back to the customer’s product in the form of additional units -with the platform just being the facilitator. That is the current position although it is still in consultation and we are unlikely to know the final rules until later this year.
A Skandia spokesman says: “We believe this is the best outcome for customers because the rebate mechanism enables platforms to negotiate discounts with fund groups on behalf of their customers and those discounts being paid back to the customer in the form of units rather than cash ensures the customer benefits in their product rather than the cash being used to offset platform or advice charges. Customers use platforms to invest in funds not cash, so it follows that rebates should be paid to the selected fund, not a cash account.”
The passive fund brigade are in full support of the proposals because they believe that it will put them on a level playing field with their active rivals - and more fully align the interests of both advice practitioners and fund managers with the end investor. Nick Blake, head of retail at Vanguard Asset Management, says : “We support the FSA’s original proposals to ban all commissions and rebates for distribution platforms and financial advice. This will create a level playing field on which all fund providers would compete on the price and performance of their funds, rather than continue to provide incentives that might be creating an access bias. This visibility should lead to long-overdue price competition in a market that has experienced rising fees over the years, despite a dramatic increase in supply.”
But John Lawson at Standard Life highlights that as the rebate ban only applies to mutual funds, as all group scheme use gross life funds, there is no issue with rebate disclosure.
I can’t think of another area of human economic activity where the internet has put an extra intermediary between the provider and the customer
“The real issue for rebates is in the retail market for Oeic and unit trusts on fund platforms and wraps where the disclosure of the rebate will expose the price and cost of the platform and the underlying deal they have extracted from the fund manager,” he says.
“This will put downward price pressure on both platform and fund management charges which is good news for customers and advisers. Some platforms have already decided to announce post RDR charge structure but some, the most expensive ones, are resisting doggedly.”
Will active fund managers to lose out?
If fees do come down then passive funds could become more popular among advisers. There is evidence that they already are doing so. According to the IMA, intermediaries are already recommending tracker funds in higher numbers.
Perhaps not surprisingly, most advisers would choose active funds if they carried the same fees as passive products, according to a poll by Schroders.
According to the Schroders’ Annual Adviser Survey 87 per cent of advisers would choose active funds over passive funds if charges were the same.
However, more than half of the 225 advisers questioned said they expected to use more low-cost, passive funds within portfolios to reduce the total fees paid by clients.
Of course, the question set by Schroders on low-cost passive funds is deliberately placed - it has already launched a range of low-cost active funds, with RDR in mind. It also said that a third of its retail fund sales come from the DC market.
Robin Stoakley, managing director, intermediary business at Schroders says: “Advisers are going to look to reduce costs - from fund costs to admin costs. If we can offer active funds that are competitive in terms of costs with passive funds, then personal DC investors will be interested.”
Yet there are many experts who do not expect to see any shift in attitude.
Indeed Lawson is sanguine about the RDR, rebates and the need for passive strategies to cut costs. He reckons that the direction of traffic in the group personal pension space is away from passive and towards active because “passive alone cannot meet member needs” of optimum return and low volatility.
He added: “You have to use funds which smooth returns - typically protected funds, absolute returns, with profits or balanced portfolios with some hedging built in. Some of the underlying funds can be passive to keep costs down but this approach needs some active elements in the mix and an active oversight.”
Speaking plainly, when IFAs and brokers do not receive any commission from fund management groups, it is not in their interests to promote the funds from those providers to their clients
Skandia agrees - it simply believes that because rebates will be disclosed advisers and so their clients will then be able to see whether they are getting value for money or not.
Its spokesman says: “The benefit of a platform pension or Sipp is that they offer a range of options both active and passive so it is up to the individual, in conjunction with their financial adviser, to decide which funds suits their needs, with cost being just one factor they need to consider.
“Under the RDR, the investor will be clearer on what services they are receiving in return for what payment to the adviser or fund manager. So the main driver for change under the RDR should be that people can assess whether they are prepared to pay more for active rather than passive management.”
Can we expect lower fund fees in general?
There is a school of thought that a rebate ban could lead to lower fees as responds to greater transparency.
Fund managers are already gearing up for the RDR and a new generation of low cost, actively managed funds has been launched, where investors can get the potential benefit of active management at a fraction of the price.
For example, Schroder UK core only charges 0.4 per cent, compared with a typical charge of 1.6 per cent for an actively managed fund.
Adrian Lowcock at Bestinvest says: “Speaking plainly, when IFAs and brokers do not receive any commission from fund management groups, it is not in their interests to promote the funds from those providers to their clients. This is the biggest challenge facing the industry and one of the main reasons RDR is being introduced.”
Aegon platform director, Gordon Greig, says: “Actively managed funds are typically priced a 150 basis points, which is more than is needed when distributing through platforms as it includes a margin to pay advisers.
“Many expect fund managers to introduce a ’platform’ class, which would set its charge at a lower level, effectively netting off currently available rebates.”
However, it is not clear cut. Julian Webb, head of DC and workplace savings at Fidelity argues that however fees are constructed, it is the total cost to the customer that counts. The fees paid under many pension contracts cover the costs of both pensions administration and investment. It is often argued that by unbundling these elements and charging them separately, consumers will be able to shop around for lower charges on each. Yet, he says that in practice, there is a lot of cross subsidy between the two elements.
“There is a suggestion that by unbundling this charge, greater transparency could lead to more competitive charges. In practice this may well not be the case. Administration costs for all customers are generally subsided by fees earned on investments. Removing this cross subsidy might end up with total customer fees increasing as administration providers are forced to recoup all of their costs via administration charges.
“Since the costs of administering a member’s account is relatively fixed in nature, charging individuals explicitly for their administration costs will inevitably impact those making smaller contributions most severely. This is because the fixed costs will represent a larger proportion of their account value. Limiting or banning rebates or cross subsidies to administration providers could increase charges overall, particularly for less affluent customers.”
Lee Smythe of Smythe & Walter chartered financial planners, is of a similar opinion. He says: “I can’t help think that by removing rebates, the most likely outcome will be increased costs for consumers, rather than cost savings. For example, some passive funds currently pay either no trail commission or only a reduced amount of 0.25 per cent, compared to most active funds which pay 0.5 per cent. If all costs are to be explicitly charged, it is likely that post RDR advisers will have a service agreement with clients which relates to the full value of funds invested, which may be 0.5 per cent or even more, thus increasing costs for passive investment.”