Beware Ryanair-style fund fees

British investors are being ripped off when it comes to hidden fund fees. Tim Bennett explains what should you watch out for.

When choosing a fund, one crucial factor is often overlooked fees. Invest £10,000 over 20 years at an expected annual return of 7% with an annual management fee of 2.5% and you will be around £5,203 (or 18%) worse off than someone who only pays 1.5% per year in fees. You'd hope product providers would make it easy to find out what you are paying in fees. But you'd be wrong.

There's a good reason why many British fund providers are happy to make fund charges difficult to compare. According to the Review of Financial Studies in 2009, the average British unit trust or open-ended investment company (Oeic) charges 2.21% of its clients assets annually compared to 1.04% in America. That's something an industry that sold £78bn of products in the last three years according to (14% more than the sales total for the previous seven years) is keen to hide.

But why the huge UK/US difference? "A lack of competition in the British market," says Jack Bogle, founder of Vanguard, the world's biggest mutual fund manager. Henri Servaes of the London Business School adds that "the disclosures are not as strong as they are in America".

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

As for where the extra fees are hidden, there's plenty of choice. Ryanair-style pricing is popular, whereby the headline rate excludes extras such as the funds platform fee, advisory fees, trading costs or the extra commission, or the fact you didn't spot that the initial fee quote only applies if you invest over a minimum amount.

The British fund-management industry also doesn't have a standardised reporting system across all products. Some firms publish fund holdings every six months, whereas in the US all firms publish every quarter. The impact? SCM Private reckons British investors are stung for an extra £2.7bn by UK mutual funds than is apparent from the published total expense ratio (TER).

Worse, "in what is allegedly a competitive industry, the British funds market, how is it that the average cost of funds has risen over the years rather than fallen"? asks Peter Smith, head of investments policy at the FSA on "That's something we are going to be thinking about."

While he's thinking, investors should watch out. Ask for a breakdown of product fees before buying and if it's not clear how much you are paying, or why, step away. It's highly unlikely most fund managers will make up in performance what you are losing in excessive costs. If in doubt, opt for cheaper investment trusts and exchange-traded funds over unit trusts and Oeics.

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.