In February, the FSA issued a paper entitled Reforming polarisation: a menu for being open with consumers. The intention was to increase cost transparency in the retail investment market. Under the terms of the proposals, advisers will have to disclose commission or fees and provide a written guide to the cost of their services before entering any agreement with a retail investor.
The guide must include disclosure of the services provided by the firm, the fee structure, commission charged and how it compares with the rest of the market.
According to research by NOP, 28 per cent of consumers do not know how financial advisers are rewarded for selling a particular service yet 59 per cent feel it is important to know exactly how much an adviser would make from a sale.
On first consideration, the idea of the menu guide has been widely welcomed by consumers, with 81 per cent of respondents to the NOP survey believing it will be a step forward in removing the cloud of confusion over retail financial services.
I must admit to having had mixed experiences myself as a consumer. In 1993, I employed the services of one of the bigger intermediary firms to arrange a package of financial services including regular payments into a free-standing additional voluntary contributions plan. The charges were opaque and certainly did not carry any comparison with what might be available elsewhere.
By contrast, in 2000, I used a small IFA to set up my self-invested personal pension. He was explicit about the level of charges and how long he would continue to receive commission from my monthly contributions. His transparency contrasted markedly with my earlier experience and his professionalism was all the greater in my eyes.
Let me tell you a little more about that onerous FSAVC agreement I entered into. I made regular savings into it until 1995. The period of its existence has been characterised by seven years of a rampant bull market, three ensuing years of misery and a little recovery since. During the 30 months that I was paying in, the FTSE All Share index hovered between 1,400 and 1,800. Today, it is around 2,200 but my plan is worth less than the contributions paid in. By any token, this is poor investment performance.
Yet the managers have enjoyed their front-end load, unit spread, 1 per cent annual management charge, monthly member charge and another fee for converting it to fully paid up in 1996. If I want to get out, the transfer value is under 50 per cent of the current fund value.
All that leakage from funds that should be working on my behalf is bound to take its toll on performance. No wonder people get angry. But the experience is not uncommon.
A few years ago, the Sunday Times Insight team published a report which calculated that the charges levied on a typical unit trust were so high that fund managers were pocketing as much as half of every pound's worth of investment growth they created for investors.
Following first-year charges for a typical unit trust, the cost of buying the trust amounted to 5.5 per cent of money invested. On top of this, the average annual management fee came to 1.5 per cent, with expenses such as regulatory and audit charges at 0.1 per cent and dealing fees at 1.3 per cent. That is a total of 8.4 per cent coming straight out of the client's investment performance. This becomes the hurdle that the investment manager has to jump simply to return the client to square one.
I would like to see the FSA go on a mission to educate the investing public. Let us tell people that there are managers who charge wholly or partly on a performance-related basis. Let us encourage investors to reject the current fee structure of mainstream managers. Let us give them the confidence to shop around. As consumers become more knowledgeable and shop around for the best possible deals, unreasonably high management fees will drive them away. Among the many benefits would be an all-round improvement in confidence.
I also want to see more funds launched that charge fees for delivering performance.
When we set up the Analyst discretionary investment management service, we decided to challenge the standard industry practice. If our funds fail to beat the risk-free return that could have been obtained by depositing the cash in Treasury bonds, we do not collect our 1 per cent annual management fee.
The quid pro quo comes when, over the lifetime of the investment contract, we outperform our benchmark, the FTSE All Share Index. Then we get to keep 20 per cent of the excess return, with the client receiving the index performance plus 80 per cent of the excess. Clients are free to walk without penalty whenever they wish.
With the benefit of hindsight, April 2001 was a rotten time to start an investment management operation, let alone one structured as a fee-on-performance model. So much for our market timing ability. The first two-and-a-half years of the bear market saw the FTSE 100 fall from 6,926 to around 5,000. But the last leg between June 2002 and March 2003 saw the market bottom out at 3,287. Just about the only way to generate positive returns was to use derivatives or short-selling. But our fund was set up as a long-term equity investment proposition, not as a hedge fund.
Inevitably, a long equity fund is correlated to the general stockmarket. We found that when every tree in the forest is being felled, there is nowhere to shelter. Accordingly, we took nothing in management fees for 14 months. Although in most cases we outperformed the FTSE All Share, we did not beat the risk-free Treasury return. The only way we got through that period was to tighten our belts and make personal sacrifices.
I am not sure you can continue doing that for extended periods or whenever the stockmarket gets into difficulty. On the one hand, we started from scratch in the middle of the worst bear market for a generation and were successful in attracting £22m of funds under management during this torrid time. On the other, our approach was a novelty and we had to fight hard to survive. Perhaps there is something in the argument that an element of remuneration should be dependable.
If more normal conditions lie ahead, now is surely the time for fund firms to demonstrate confidence in their investment prowess. I want to see more funds launched that make the bulk of their money after having delivered performance. While our business model might be extreme in the way it shares the pain in bad markets, it is capable of adaptation to ensure a fair balance between the need to stay in business and the need not to soak the clients.