Don’t get ripped off by the City – here’s how to be a smarter investor

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.

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?

The FCA’s biggest gripe with the fund management business was its lack of consistency when it comes to charges.

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

What’s even more irritating than all of this is the fact that British investors seem to be getting ripped off generally. Fund management doesn’t have to cost this much. For example, a report from the True and Fair campaign says that the average UK investment fund charges 58% more in fees than the average US fund.

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.

But it’ll take time. So meanwhile, if you’re thinking of buying any actively managed fund, take a look at this calculator from the True and Fair campaign. It should give you a better idea of how much a fund truly costs, and help you choose cheaper funds – I wrote about the tool in more detail last October.

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.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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  • mikeT

    A hidden fee that should be highlighted is in FX. I recently bought a Euro bond fund through Fideity. Nothing in the sections on “Fees and Charges” mentioned that the traded rate is adjusted by 1% before it gets to me (though it does appear if you hunt hard in the general Key Investor Information). So – assume I bought the fund using GBP on day 1 and sell it on Day 2, nothing changes in terms of fund price or FX and I sell on Day 2. I’m immediately down 2%. This is a fee, pure and simple, a should be described explicitly alongside AMC, TER and platform charges!!
    Moreover, the confirmation of the trade should report both the gross FX rate (so we can be sure it falls within the daily range and has not been subject to any further haircuts) and the net (to verify it is only 1%).
    In any case, why as much as 1% for the most liquid, automated market in the world? The cost of admin? I don’t think that can be justified. And if you complain, the stock answer is that “we charge in line with other market leaders”! In other words – no competition, just a cartel.

  • mikeT

    PS Consider the cited Fidelity World Index Fund. You are charged in GBP. The fund then buys a number of equity and/or indices in their base currency, such as USD, Euro, Yen etc Do you know how much you are being charged for this conversion? Does Fidelity make this accessible and public? Not as far as I can see.
    Maybe it is absorbed by the 30bp management fee or the 35bp platform fee. I doubt it.

    • FR

      There will be always hidden charges to protect the magnificent salaries. I was gutted when i found out a yearly charge of 10% on a foreign share that is held by the global depository bank Deutch Bank. Just cannot get away from crooks even if you do DIY.

      In the end modern finance is a covered feudal regime.

  • Ed Bowsher

    Thanks for these comments. These FX charges are way too high. I hope to look at this issue before too long. No guarantees though.

  • mikeT

    Ed – an investigation into FX charges would be very welcome. Thank you. I would hope that, one day, the whole issue of transparency is addressed. Going back to buying a GBP fund on Day 1 and selling it on Day 2 – I lose money even if nothing has changed. I can deduct 1 day’s AMC, Platform fee, brokerage (though often “free” for ISAs) etc yet it still does not add up. I just have to accept this is part of the mysterious “TER”. This is wrong! Any investor should be able to audit all profit or loss. We should also get regular (comprehensible) fee statements, just to prove that all is honest!