Financial advisers come in for a lot of stick these days. So do fund managers. Sometimes for good reason, less often not. But there is one group within the financial services industry that generally seems to pass unnoticed by those of us who make a living criticising other people.
It's the wealth managers, or discretionary fund managers. These are the people to whom you take lump sums (or to whom your independent financial adviser recommends you take lump sums) to be sensibly and profitably managed on your behalf. There are plenty of them about for the simple reason that the holy grail of all service businesses is to capture as much of each client's revenue streams as you possibly can.
That makes wealth management a great add-on to pretty much any financial business. On top of the hundreds of stand alone businesses, old-fashioned brokers have reinvented themselves as wealth managers better a regular fee than irregular trading commissions and you will have noticed that the banks have wealth management divisions to whom their branch staff frantically up sell everyone with any real cash.
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This is not, in theory, a bad thing. More of us have large-ish lump sums we have to deal with, but not all of us want to manage our own money. Not all of us feel we'd be up to the job even if we did want to. And good wealth managers aren't just investing money, they should be actively managing it too. They'll make sure you use your capital gains allowances properly every year, advise you on tax efficiency, and arrange your affairs to provide you with the income you need.
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And finally they will provide you with a social service. Most wealth managers are charming (they have to be); they are always at the end of the phone; and if you were to drop by their offices you can be sure of a coffee if not lunch. Some of the nicest parties I have ever been to have been thrown by wealth managers.
The catch? Wealth managers, like everyone else in finance, have got into the habit of charging rather too much for their services. At the best firms, you pay a management fee not a flat fee, but an annual percentage of your assets of anywhere from 0.75% to 1.5%. But in most places you also pay commissions or 'administration fees' when assets are bought or sold for your portfolio.
And there are other costs that aren't so transparent. You get no interest on any cash you may have in your trading fund, for example, and if you buy foreign shares, there is a good chance that the exchange rate you receive won't be the one your manager got. His firm will have taken a cut.
So here we go. What does it all actually cost you? I've visited www.pamonline.com, a nice site where you can look at all the wealth managers and have a stab at figuring out the answer. I've chosen one representative wealth manager to run the numbers on, and made a few assumptions.
I'm assuming that I have £500,000, that £50,000 of it is in cash, that it is invested by my friendly expert in 15 different funds and that, on average, he replaces about five of them every year. The basic management fee is a low-sounding 0.75%. That's £3,750. Add in VAT and it is £4,500.
Every time he trades for me, he charges me 1.2% of the value of the asset he sells or buys, up to £25,000. Beyond that he charges me 0.5%. Five buys and five sells a year and that's £3,375 gone in trading commission alone.
But of course I'm not just paying my manager. I'm paying the fund managers he has chosen too. Let's say the funds he has put me into have an average total expense ratio of 1% (I'm assuming he is using the cheaper institutional share classes or that he is buying investment trusts). On my £450,000 worth of investments, that's another £4,500.
Next, we must take into account the fact that his company pays interest on cash at 0.75% below (yes, below!) the Bank of England base rate. The base rate is 0.5%. I suppose I should consider myself lucky that he doesn't actually charge me for being in cash, but nonetheless I think we should consider the lost interest to be a cost. I'm conservatively putting it at 1.5%. That's another £750.
There could be more but let's stop here. The total annual cost? £13,125, or 2.6% of the total value of my assets. Of course, the total sum may be much less at some managers and more at others. But nevertheless, our example manager needs to make 5.3% just to protect you from inflation and his costs at the moment. UK equities have made an average real return of 5.1% a year since 1900, with dividends reinvested.
And returns from the wealth management sector are, with some notable exceptions, not great research inthe FTlast year suggested five-year returns running at an average of about 3.2%, but thanks to an impressive lack of transparency on the part of the industry, returns aren't always clear.
On the plus side, at least you aren't paying your wealth manager by the hour as you might be if he were a lawyer or an accountant. This means you can ring him up for a nice chat, drink his coffee or badger him about your performance as much as you like for as long as you like. No extra charge.
This article was first published in the Financial Times.
