Good news. Vanguard is coming. The US-based, low-cost fund manager is launching in the UK, “confident that they will have the lowest annual management fee in their sector – cheaper than competitor funds and ETFs”.
This matters. The cost of investing in active and passive funds in Britain is high, with the average unit trust charging around 1.5% in management fees alone. And the management fee is only half the story. Think of all the other charges: trading commissions, stamp duty, research, marketing, compliance, accounting, etc. Then there is the massive bid/offer spread on lots of funds, to say nothing of the spread on the stocks they buy for the funds.
You might think all these costs should be borne by the fund management firm from their fees. They’re not. Instead, they’re taken from the fund’s assets on top of the management fee. Alan Miller, former CIO of New Star, and now at Spencer Miller Private, claims that once you take dealing charges into account, the total annual costs of a fund run to “more like 3%”.
A reader wrote to me a few weeks ago. He had around £150,000 to invest. His financial adviser told him to put it into an equity fund. The charges? 1.5% for the adviser (cut to 1% after some discussion) and 1.55% for the fund manager, out of a forecast 7% return. In other words, 36% of the return will go on charges each year. And that’s only if you ignore the hidden charges and assume the return really is 7%, which is highly unlikely.
How can an investor make anything even approaching a market return after all that? The reader points out that (again assuming the 7%) he’d be left with a return of little more than 4%, despite taking on all the risk of being in the equity market. Why, he asks, should he do this rather than just get a fixed-rate savings bond at 4%? Quite.
There are alternatives. Miller builds client portfolios using only ETFs, then charges 0.75% a year on top for his advice. But Vanguard is in another cheapness league. Fund fees are very low (from 0.15% a year) and they’re more transparent than most: all expenses incurred running the fund come out of the management fee rather than the fund’s assets. So when Vanguard says its UK Equity Index Fund will cost you 0.15% a year, that’s genuinely all it will cost you.
The fund management industry tends to charge whatever it can get away with. That’s reasonable in that the industry, like all others, is made up of profit-maximising firms: they charge what we’ll pay. My hope is that the arrival of the likes of Vanguard along with the ongoing expansion of the ETF industry will mean they can get away with less – something that will improve investor returns and, longer term, the reputation of the sector.