Fund Research & Insights
Are You Paying Too Much In Fund Charges?

Fund fees can be a significant predictor of future returns, suggests Morningstar research. The fund management industry is under increasing pressure over fees and, in many cases, costs have fallen. However, an anomaly from recent regulatory changes has left many investors who bought direct from a fund manager paying a higher price for their funds than those buying through an intermediary.

The Retail Distribution Review (RDR) changed the way people bought investments: previously investors paid for funds with all the costs bundled up together – adviser costs, platform costs and fund management costs. They bought this in one package, with a fee of around 5% upfront and an ongoing 1.5% charge each year.

The problem with this system was that it was difficult for investors to disaggregate who was paid what and therefore investors struggled to judge whether the costs were justified. Also, investors ended up paying this all-in fee whether or not they had used a platform or adviser.

The RDR brought forth a brave new world. Fund managers launched new share classes with only the fund management cost included. These share classes were notably cheaper (at around 0.65% to 0.75%), and investors paid any adviser and platform costs on top. All intermediaries – including platforms and advisers – were obliged to convert clients to the new share classes from April this year and in practice, many platforms and advisers had completed the process by the end of last year.

Investors Paying Higher Fee For Poorer Service

The problem is that this compulsion did not apply to direct investors, in particular those who had bought direct from the fund managers. In many cases, these investors are still sitting in share classes with a total expense ratio (TER) of 1.5% or higher, even though they are not receiving any advice or platform services.

Darius McDermott, managing director of Chelsea Financial Services, says: “If investors held funds on a platform, they had to be converted to the new share class by April of this year. If investors are not with an IFA, or a platform, they may still be being charged 1.5%. Some fund managers are trying to get rid of these back books and groups such as M&G have set up their own platforms to enable investors to switch, but not all.”

Investors might reasonably ask why there is no obligation to shift these direct investors. However, Danny Cox, head of advice at Hargreaves Lansdown, highlights the dilemma: “With a predominantly direct offer service, it would not be appropriate for us to make investment decisions on behalf of clients.

“However, we have made it easy and free for investors to switch units if they wish to do so. The same applies to fund managers who should not normally be making alterations to investor’s share classes without their instruction.”

Time To Phase Out Older Share Classes?

While the Investment Association confirmed it has no plans to introduce similar obligations to those placed on advisers and platforms, it has called for a ‘sunset clause’ on the ongoing trail commissions paid to financial advisers, on funds that were sold under the old charging structure.  This would ensure that the old share classes are progressively phased out.

In the meantime, direct investors will be responsible for making any switch. Some will be able to do this through the fund management group. M&G, for example, which has around 190,000 direct investors, is launching a new direct platform. This scraps initial charges and reduces annual fees, making it cheaper – in most cases – to invest with the group than through an intermediary, such as a platform or IFA.

Even if the fund manager has not set up an alternative option, investors can often save money by switching their holding through a platform. For example, for a popular fund, such as the Invesco Perpetual High Income fund, the old share class has a total expense ratio of 1.67%. Investors also need to consider the initial fee – up to 5% – on any regular savings. To buy the same fund through Fidelity FundsNetwork would cost 1.22% (0.87%, plus 0.35% in platform charges) with no initial fee.

Don’t Switch Funds, Switch Share Classes

While it is easy to dismiss a saving of 0.45%, on a pot of £50,000 invested over 20 years, this would add an additional £4,700 to returns.  With interest rates at 0.25% and the returns from investments likely to be structurally lower from here, this represents a ‘free’ way to generate better returns.  This is particularly important for lower return investments such as bond funds.

However, Isa investors should note that they will have to do an Isa transfer to retain their benefits, rather than selling out of the fund. There are administrative hoops for investors in switching, but for older investments, it is worth checking the annual fee.

Returns are hard to come by in this low interest rate environment and paying less for exactly the same fund is an easy way to boost returns.

Source: Morningstar. Cherry Raynard | 13/10/2016

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