I groaned inwardly over breakfast this Sunday when I read the front page headline in the normally excellent Observer. Yet another story about how fund managers are taking huge fees which are destroying the value of our long term savings. Yet more irresponsible scaremongering by the story’s promoters.
Some of the assertions in this particular story were laughable. One claimed, for example, that charges are costing pension funds £67 billion a year; yet the investment management industry’s total revenues from all clients was in fact £11 billion in 2010. Another claimed that management fees for pensions are 1.5 per cent a year, as in the retail market, when in fact the average management fee across all business (including pension funds) is just 0.3 per cent.
Most corrosive however is the constant refrain about “hidden charges”. The narrative goes like this: the manager will tell you what explicit charges are levied, but there are others on top which you aren’t told about, and then of course there is all the money that is creamed off in fees for trading the underlying stocks. The first is easy to deal with: the “other charges” (which go not to the manager, but to the providers of other services, such as the registrar, trustee and auditor) are included in the “total expense ratio”. This is disclosed up front to investors – as is required under European law.
But what about those hidden trading costs? Well, they are not hidden: they have to be disclosed every year in the fund accounts. They represent the cost of investing, just as you or I would face if we invested our money directly. As such, the revenue does not go to the manager, but to brokers which are completely separate from the fund manager. Indeed the latter has a duty to obtain the best deal for the client. Of course, the biggest winner, at least for trades in UK equities, is the Government through its 0.5 per cent stamp duty charge.
But there is an easy way to resolve this argument. Funds publish their prices every day, so it is possible to measure the returns to investors very accurately. If these “hidden charges” really were hitting the investor hard, then you would see it in the average net return. For example, if the TER is 1.75 per cent and the fund underperforms the relevant stock market index by 2.75 per cent a year, then the combined effect of investment decisions and the associated costs is costing investors 1 per cent a year.
Well, we did those calculations a couple of years ago. The results are in this paper. They show no sign of investors losing out from “hidden charges”. Indeed, these numbers happened to show that trading had a net positive effect for investors, with the gains resulting from investment decisions comfortably outweighing the associated costs.
I called these stories irresponsible scaremongering. Those are strong words, but justified. It is scaremongering because it puts misleading figures into the public domain. And it is irresponsible because it is telling people they should not be saving for their future, when the responsible advice is that they should.
Richard Saunders is chief executive at the Investment Management Association