Don’t get ripped off by the City – here’s how to be a smarter investor
With their high charges and dodgy tricks, fund managers can be very poor value for money. But there are simple ways to avoid getting ripped off, says Ed Bowsher.
Here at MoneyWeek, we spend a lot of time telling you that fund managers are in the main poor value for money.
And it seems the financial regulator agrees with us. The Financial Conduct Authority released a pretty damning report into the industry last week. Its main gripe was that too many managers are hiding the true cost of their funds by using various dodgy tricks.
Some of what goes on in the industry is shocking to anyone who doesn't work in finance. Some of it even surprised me.
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But the good news is that there are simple ways around the high charges and ludicrous practices as I'll show you in a moment.
Which charges figure is the most accurate?
Charges matter a lot. Every penny you spend on the cost of investing is one less penny available for your savings pot. One percent might not seem like a lot, but over the years it can add up to tens or even hundreds of thousands of pounds going missing from your pension pot.
So it's important that you get an accurate picture of how much an investment is going to cost you. But that's not easy to get out of fund managers.
You see, many fund management companies like to use the AMC' (annual management charge) figure to show the cost of their funds. But this figure excludes a wide range of different costs, including trustee and audit fees.
The FCA prefers the ongoing charges figure' (OCF), as its gives a more accurate picture of the costs. But even this figure isn't comprehensive.
And what also really riles the FCA is a lack of consistency. Several fund managers use the AMC on one piece of literature and the OCF on another. They might even use a third cost figure the total expense ratio' (TER) on another document. This all makes it harder for the likes of you and me to figure out which funds are expensive and which aren't.
But it gets worse. The FCA is also irritated that various fund management expenses are taken from client money' in other words, they're directly removed from your investments.
In particular, the FCA cites charges paid to investment banks to buy research on companies, as well as fees for access to company management.
Now, the FCA doesn't object to the fees themselves, it just thinks that the fees should be paid from the fund management company's own cash.
But personally, I think both charges are ridiculous in the first place.
Fund managers are supposed to be investment experts. They employ their own analysts and not on minimum wage to help with investment decisions. So why on earth should they be paying for research from investment banks?
The fees for access to company directors annoy me even more. If I was the CEO of a FTSE 100 company, I'd be furious if one of my investment bank advisers was charging fund managers to fix up a meeting with me. Most large companies have their own investor relations departments who are quite capable of organising meetings.
Sure, any CEO has to decide how much time he wants to spend meeting fund managers maybe he'll only do this when results are released but that decision shouldn't be affected by fees paid to investment banks.
Funds are a lot cheaper in the US
Why are US funds cheaper? It seems to be a combination of better regulation and more competition. The Retail Distribution Review (RDR) should help with this in the UK, by forcing funds to compete more on price, rather than the amount of commission they can pay to advisors.
Alternatively, skip active managers altogether. Many of them fail to beat the market in any case. Instead, you can go for a passive fund. These funds track a particular index instead of employing expensive stock pickers.
The cheapest passive funds charge as little as 0.15% a year, far lower than your average actively managed fund where the charge is more like 0.75% (before all the hidden costs).
Last month I highlighted the Fidelity World Index fund, which comprises all the large companies on stock markets round the world. Its OCF is 0.3%, and there shouldn't be many hidden charges on top of that.
If you want to focus on the UK stock market, the Vanguard FTSE UK Equity Index fund is another cheap option.
In fact, you can use passive funds to build an entire investment portfolio, diversified across a range of assets, which should set you up comfortably for the long term.
My colleague Phil Oakley tells you how to do it in his Lifetime Wealth newsletter. You can find out more about it here, and I'd recommend you do it's an incredibly simple investment strategy which should suit most people looking to save for the long run, and it'll save you an awful lot of money in fees as well. So do take the time to check it out.
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Ed has been a private investor since the mid-90s and has worked as a financial journalist since 2000. He's been employed by several investment websites including Citywire, breakingviews and The Motley Fool, where he was UK editor.
Ed mainly invests in technology shares, pharmaceuticals and smaller companies. He's also a big fan of investment trusts.
Away from work, Ed is a keen theatre goer and loves all things Canadian.
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