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Cost calculations

What is a fair price – and how can you tell whether you have paid it? This debate has featured recently in the press in terms of investment products. The IMA has attempted to shed some light on the issue with research unpacking the costs.

Retail funds give investors access to financial markets and asset classes at a lower price than they could achieve on their own. By buying into a fund, investors benefit from economies of scale – and get the added benefits of diversification, custody and professional management.

You are also paying the manager to manage your money for you, so there are ongoing costs.

Our research started by looking at tracker funds, not because they are cheaper but because with a tracker it is easier to work out what you are paying. “Ah, but,” say the pundits, “the TER does not account for all the charges – there are ‘hidden costs’ on top of this.” The TER includes costs charged to the fund, such as registration, audit and depository fees, as well as the annual management charge. (The latter includes trail paid to advisers.)

These “other” costs include costs of investing the underlying portfolio – stamp duty on transactions made by the fund managers are generally the biggest component – as well as dealing costs.

If you compare the net returns on trackers – the returns after all costs and charges have been deducted – with the performance of the relevant index, then you should get a good idea of the real cost of investing. These other costs are not included in the definition of the TER, so you would expect the effect of them to increase the cost of funds to a level over and above the TER but this is not the case.

On a FTSE 100 tracker over 10 years, the average TER is 0.9 per cent but the difference between the FTSE 100 and the net returns achieved by the average tracker is only 0.81 per cent. Similarly with All Share trackers, the average TER is 0.82 per cent but the difference between the net performance of the average fund and the All Share is only 0.55 per cent over 10 years. In other words the actual costs paid by investors work out at slightly less than the TER that is disclosed to investors.

Similarly, there is no evidence of hidden costs dragging down performance for actively managed funds. A comparison of net returns with TER for active funds gives a measure of the com-bined impact of investment decisions and dealing costs. Over the last 10 years, after charges, the average actively managed UK all companies fund performed better than the FTSE All Share index.

The top 10 per cent of actively managed funds in the UK All Companies sector delivered at least 64 per cent growth over five years, outstripping the FTSE All Share index by at least 2.5 per cent a year (28 per cent in total), even after charges. The least well performing 10 per cent produced returns of zero or less over the same period. This is equivalent to underperformance of the FTSE All Share Index by 2.6 per cent a year. The average TER for actively managed funds is 1.75-2 per cent. Investment costs will have contributed to the balance of some 1 per cent of under-performance but much of the under-performance of these funds is likely to be due to investment selection.

It is good to see the issue of costs getting an airing. Advisers should be in a position to explain to clients how it works.

Ginny Broad is head of communications at the Investment Management Association

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