The hidden costs of
investing in funds
What the financial regulator is doing about hidden charges. How you can avoid them and make the most of your investment returns.
This guide is brought to you by Interactive Investor At Interactive Investor, we believe that people should be free to control their own investment decisions. This is why we don’t just provide stock broking, we bring together the facts, tools, opinions and analysis that investors need to help make their decisions with confidence. We make it easy for you to get insights into the companies and sectors you follow. Our straightforward pricing lets you buy and sell UK and international shares and funds for a single flat fee. Are you ready to join the UK’s most active investor community? You decide. In May 2012, Which? Money magazine’s review
of
fund
supermarkets
ranked
Interactive Investor in first place out of the 23 reviewed. Candid Money (www.candidmoney. com) has also rated Interactive Investor as providing the best value service for SIPP and ISA investors who hold managed funds. . Interactive Investor Trading Limited is authorised and regulated by the Financial Conduct Authority, and is a member of the London Stock Exchange. Registered office: Standon House, 21 Mansell Street, London, E18AA. Registered in England. Company registration number 3699618. 2 | The hidden costs of investing in funds
Introduction
W
hile investment returns are
While all investment fees need to be
rarely predictable, investment
transparent, providers will still be free
charges are something you do have some
to create their own charging structures,
control over.
so you will need to take some action to ensure you maximise your returns.
The Retail Distribution Review set up by the Financial Services Authority (FSA) seeks to
In this guide, we show you exactly what
ensure hidden charges are a thing of the
you need to do with your investments so
past. This will allow investors to make
that you can end up with more money in
an informed decision about where and
your pocket or funds portfolio.
who they invest with.
This guide will help you understand the following:
Annual Management Charges and hidden fees
What the Retail Distribution Review (RDR) is
The history and future of trail commission
How to get hidden fees rebated back to you
How to select where you buy your funds
Managing investments yourself
The pros and cons of advice
The hidden costs of investing in funds | 3
What is the Annual Management Charge? Every fund charges you a certain
learn the fund manager only gets half of
amount for day to day management.
this AMC. The rest of the charge goes to
This amount is referred to as the annual
the broker or IFA and any platform used
management charge or AMC and on a
to buy the fund. The ‘free account’ you
typical fund is a 1.5% charge. Many
have or the ‘free advice’ you received
investors will probably be surprised to
may not be as free as it first appeared.
0.5%
ion Trail Commiss
1.5% AMC
0.25% Platform Fee 0.75% Fund Manager
4 | The hidden costs of investing in funds
Where does the AMC go? Even if you’ve held funds for years, you
much of your fund’s AMC as possible,
may not know that the AMC you pay on
you’ll need to invest with a provider who
a fund is deducted from the price of the
returns this charge to its customers.
fund every single day – meaning that you are less likely to notice its deduction.
If you want to switch to a provider that does this, the process could be as simple
However, the amount you are paying
as taking about 10 minutes to fill in one
really does add up, especially when
form to open a new account.
returns are low. Instead of you paying for advice you The good news is you can get a significant
haven’t received in years (if at all) you
part of the annual management charge
could be receiving commission straight
back, which will automatically increase
into your account. The reward is likely to
the overall sum you get from your
be well worth it.
investments. To ensure you receive as
How a 1.5% AMC affects the growth you see from your fund Actual growth
3%
5%
7%
Growth after AMC
1.5%
3.5%
5.5%
% of return as AMC
50%
30%
21%
The hidden costs of investing in funds | 5
What is the RDR and why is it important? The RDR is likely to cause perhaps the most far-reaching shift in financial services since the Financial Services Act of 1987. It aims to ensure that financial advice is transparent, free from bias and that investors receive a more professional and consistent service from their advisers. It is a potential game-changer for the way people receive financial advice, and its impact is likely to reverberate across the entire financial industry. It will also have an impact for many self-directed investors, particularly those buying funds through platforms. The RDR will affect how much investors pay for investments, where they buy them from and even how much those investments are worth over the long-term.
Financial Services Authority confirmed RDR dates for Advisers and started consultation with execution-only brokers. The expectation is that all platforms should have transparent pricing by 1 January 2014
RDR Timeline
1 JULY 2012 Interactive Investor introduced transparent pricing and full rebate of all fund fees 18 months ahead of RDR requirements
6 | The hidden costs of investing in funds
Hidden charges banned from 2013 There are two parts to the Retail Distribution Review: The first part deals with the provision of financial advice and who pays what to whom. Its goal is to build a more professional, better qualified advice industry. The second part deals with fund platforms, such as Fidelity FundsNetwork, Hargreaves Lansdown and our own Interactive Investor platform, and aims to ensure that hidden charges and incentive payments to providers are a thing of the past. While the first part of the RDR is ready to go at the start of 2013, the second part is still in a discussion phase, though some platforms have already moved their pricing to become RDR-compliant already.
Funds bought through advisers up to this date will continue to deliver trail commissions to the adviser unless you transfer your holdings or sell them
1 JANUARY 2013 RDR DAY FOR ADVISERS
Funds bought through advisers after this date will be free from hidden fees. Financial advice will move to transparent and clear pricing – but only for new investments
Pressure will build on the many big providers who have yet to disclose their RDR pricing
1 JANUARY 2014 RDR DAY FOR EXECUTION ONLY PROVIDERS
Funds bought through execution-only providers and fund supermarkets from this date will be free from hidden fees and have fully transparent pricing
The hidden costs of investing in funds | 7
The history of trail commission Unlike execution-only providers, advisers have usually provided advice upfront for their clients who invest in funds and received the hidden 0.5% trail commission amount, which was designed to pay for advice. However, this one-time advice can lead to a lifetime of trail commission, irrespective of whether a customer ever sees their adviser again. To further complicate the issue, some products offer higher commission payments than others, which – rightly or wrongly – led to the perception of bias. As an example, an adviser who was dependent on commission would have little hope of earning much income by recommending a client to stick with cash or other noncommission paying investments during periods of market turmoil. This would be the same if they were to recommend exchange-traded funds, or investment trusts, both of which have merits for private investors.
What you need to do You can take action to make sure that you’re not paying for advice you don’t receive and that you make the most of your money.
Action points
There is a danger that unscrupulous advisers move to re-adjust their clients’ portfolios ahead of the RDR deadline to prolong the period over which they can take commission. Ensure that all changes are necessary and if in doubt, do not switch.
8 | The hidden costs of investing in funds
Does RDR make hidden fees a thing of the past? Not quite. As a result of the RDR, advisers will no longer receive commission payments on new fund investments made after 1 January 2013. Instead their clients will move to a ‘customer-agreed remuneration’ basis. This means that any fee received by the adviser, must be agreed upfront with their client before the advice is given. While investors may be reluctant to start paying for investment advice upfront, this advice has never actually been free and you can be sure they were paying for it somewhere. Although charges for advice will not be any cheaper, they will now be transparent. There are likely to be fewer hidden charges, and in many cases investors may be paying similar prices for fund management to large institutions. However, as part of the interim rules, advisers can still charge trail commission on certain types of business and they can continue to accept trail commission after the 30 December 2012 cut-off point, providing the recommendation to make the investment was made before the RDR deadline.
Ensure your adviser isn’t just collecting your trail commission for nothing – they should be providing regular updates and demonstrating why the fund is still appropriate for your needs.
For platforms, ensure that you are not paying charges for which you are not receiving any service. In other words, select a provider that refunds the trail commission and any other income they might receive from fund providers or platforms to you in full.
The hidden costs of investing in funds | 9
How does this affect fund supermarkets? Fund supermarkets have been an important part of the democratisation of financial advice, bringing top funds within reach of self-directed investors. On the surface, their charging looks straightforward. You buy funds through a website – you pay a small fee – end of story. In fact, there is a vast difference between how different providers charge for funds and the price you pay can significantly affect the long-term return on your investments so it is worth ensuring that you get the best deal. And it is not just on fund rebates where you need to be wary of how much you pay; there is also considerable debate around payments made from fund providers for ‘recommendations’.
What difference does your choice of provider make? As just one illustration of this, the following example shows the difference in what your self-invested personal pension (SIPP) provider would be worth if you invested through Interactive Investor rather than a provider who paid no rebate: Interactive Investor
Provider paying no rebate
Difference
Year 1
£105,987.16
Year 1
£105,500.00
£487.16
Year 5
£133,844.64
Year 5
£130,696.00
£3,148.63
Year 10
£179,436.28
Year 10
£170,814.45
£8,621.83
Year 15
£240,852.16
Year 15
£223,247.65
£17,604.51
Year 20
£323,584.65
Year 20
£291,775.75
£31,808.90
Figures are based on an initial investment of £100,000 into a SIPP with a gross yield of 7% and a net yield of 5.5% after deduction of 1.5% AMC. It assumes an average rebate of 0.64% for Interactive Investor versus a provider who pays no rebate. Pricing is subject to change. In the example above the fund rebate and any income received is reinvested. The Interactive Investor return is net of the £120 + VAT annual Interactive Investor SIPP fee.
10 | The hidden costs of investing in funds
How much rebate could I get? For most funds the annual charge is 1.5%, which is allocated as follows: • 0 .75% goes to the fund manager – for managing the fund • 0 .5% is paid as commission to IFAs (independent financial advisers) or to the provider who initially sold you the fund. This is known as trail commission. • 0.25% is paid as a fee to the fund platform (eg Cofunds). Fund platforms act as the intermediary between advisers/execution-only brokers and the fund managers. We accept that some level of administration fee is reasonable, but the way it is charged within the AMC means it is not transparent and may not reflect the true cost of providing the service. In addition, most platforms share their 0.25% slice with the fund supermarkets. Some platforms have revealed these payments, but many haven’t. For example, Interactive Investor uses Cofunds as the fund platform. Cofunds administers the fund relationships and it lists new funds and responds to all the changes. It also processes all the fund deals a customer makes. Cofunds shares the 0.25% platform fee with Interactive Investor, which returns its share of this platform fee, as well as the trail commission, to customers – giving an average of 0.64% returned each and every year, per fund.
The hidden costs of investing in funds | 11
What type of fund investor are you?
ACTIVE
Well-run, actively-managed funds are often the foundations of a good diversified portfolio
ACTION
Ensure your investments are working hard enough for you
Does your fund provider pay a rebate?
YES
Well done. People who are involved with their investments will have already ensured that they are getting a rebate
ACTION
It is important to know that not all providers give the same rebate. Check how much you are getting back
How much rebate are you getting?
“SOME OF THE TRAIL�
Typically providers may offer to give back up to half of the trail commission available (between 0.15% and 0.25%)
ACTION
Challenge your provider and see if they are willing to improve this. Transfer your funds to a provider that will offer better terms
12 | The hidden costs of investing in funds
PASSIVE
The benefit of tracker/index-based funds is that they typically come without the kinds of fees that active funds carry
ACTION
Many people have avoided activelymanaged funds because of these fees. The rebates available today make actively-managed funds worth another look
NO
If you bought your fund through an IFA or even a fund supermarket there is a good chance that they are still receiving the trail commission – every year
ACTION
NONE
You have either decided that funds are not for you or you are just starting out in planning your financial future
ACTION
Funds form the bedrock of most investors’ portfolios due to the immediate diversity and stability they can provide. Consider the role of funds in your plans
DON’T KNOW
The rule here is, “if you don’t know, you are probably not receiving any rebate”
ACTION
Ask yourself if you should be receiving this as a rebate each year instead
Check your statements or get in touch with your provider. If they won’t say, transfer to someone who will
“ALL OF THE TRAIL”
“ALL OF THE TRAIL – AND MORE”
There are currently very few places that will do this. Some may even redefine the balance between trail and platform fees
ACTION
See if you could get more, but make sure you weigh up all the costs. You can try our calculator at iii.co.uk/fund-calculator
Congratulations! You understand that “where you buy your funds” can be as important as “what funds you buy”
ACTION
You are already maximising the return on your funds, so now you can focus on your investments with confidence
The hidden costs of investing in funds | 13
So how do I get the extra rebate available? If you’re going to move your investments to generate extra income then it probably pays to research the market and determine who offers you the best rebate for the funds you own, or are considering buying. Don’t forget that it is not just the trail commission, but the additional platform fee that also makes a significant difference. If you bought your fund through a fund manager, you can take the “change of agency” route whereby you fill out a form and the trail commission will then be paid to the new agent. Typically they will take a percentage of this and return the rest to you. The alternative is to transfer your holdings. This isn’t as awful as it sounds! You simply have to open an account with your new broker, fill in and send back a one to two page transfer form and that’s it. Your new broker will then arrange to transfer your investments over and within a few weeks, you can start to benefit from the extra trail commission and share of the platform fee available.
Rebate available on Invesco Perpetual High Income fund Provider
Annual Rebate
Quarterly Charge/ Inactivity Fee
Net Rebate (over 10 years)*
Interactive Investor
0.64%
£20 (equivalent commission credit)
£3,491
Alliance Trust Savings
0.50%
£10+Vat per account
£2,739
Bestinvest Select
0.25%
£0
£1,375
Hargreaves Lansdown
0.25%
£0
£1,375
Barclays Stockbrokers
0.20%
£0
£1,100
TD Direct Investing
0.50%
0.35% Platform fee
£825
Selftrade
0.00%
£8.75 + VAT per quarter
£0
Share Centre
0.00%
£0
£0
Fidelity
0.00%
£0
£0
*Source Interactive Investor: Calculations are based on investments of £10,000 into the fund each year, assume no investment growth and are net of any fees. Data from 7 November 2012.
14 | The hidden costs of investing in funds
How do I invest without an adviser? Branching out on your own can seem daunting, but it is a fantastic opportunity to generate a portfolio that is designed specifically for you and caters for your personal needs. You can amend it as your needs change – if you marry, have a baby, or change jobs, for example – and build it to suit your investment preferences. With more than 2,000 investment funds, a further 600 or so investment trusts, 800+ exchange traded funds (ETFs) and thousands of equities available in the UK, covering a huge range of objectives, asset classes, company sizes and geographical locations, the toughest call is choosing between them. So how should you go about it?
There are 5 steps to selecting the right investments for you: Step one: Understand your personal risk level Most portfolios will include equities, cash and fixed interest investments, such as corporate bonds and gilts, but these each come with different exposure to risk, so how you allocate your money between these asset classes will depend on your financial goals and willingness to accept losses. So the first step is to ascertain if you are a low, medium or high-risk investor. There are many online risk questionnaires available, such as the one you can find at http://www.iii.co.uk/riskquestionnaire. A quick Google search will turn up a variety of similar questionnaires from the major fund and insurance groups.
The hidden costs of investing in funds | 15
Step two: Know your type Your long-term goals will determine your investment style.
INCOME: If you’re looking for regular returns in the form of dividends or you want to boost your income in retirement, investing for income makes sense.
GROWTH: If you have years to save, investing for growth might be a more suitable strategy. Growth investors focus on companies whose profits and share prices are likely to outperform the stockmarket over time. As your lifestyle and goals change the balance between these strategies within your overall portfolio should also change.
Step three: Diversify If the past has taught us anything it’s that there are no guarantees of investment success. Having a diversified spread of assets can significantly reduce your level of risk whatever the financial climate. A well constructed portfolio should be diversified in a variety of ways, including overall investment style, number of individual asset classes, spread of geographical allocation and the approach of the fund manager. Many investors do not have the money or the time to manage a portfolio of individual shares, but can get cost effective and rapid diversification by investing in funds, where money from numerous investors is pooled and invested by a professional fund manager. Whatever type of investor you are, diversification is key.
16 | The hidden costs of investing in funds
Step four: Choose your investments Once your asset allocation is decided, it’s time to choose your investments. The range of investments can seem overwhelming, but the following tools are available to help you narrow down the range of choices so that you can make your own decisions.
Stock and Fund Filters
In depth Fund Factsheets Discussion Boards Editorial research and analysis Risk Analysis Tools If you’re still not sure, Interactive Investor’s range of Model Portfolios and Ready-made selections are designed to match your risk criteria and investment objectives. These model portfolios will typically be monitored for you and rebalanced based on fund manager changes or performance. Funds of funds are also options, but be wary of the additional performance fees.
Step five: Monitor your decisions The process of building a portfolio mustn’t end when you’ve invested your cash. To get the best from your investments you need to regularly review them, so read monthly updates from managers and do a proper review at least every six months. Traffic-lighting your investments can be a successful strategy. Select some key criteria, such as performance of your investment against the equivalent sector average, change of risk levels, change of fund manager etc. Then assess your investments on a regular basis, switching out from ‘red’ flagged ones and reviewing ‘amber’ ones.
The hidden costs of investing in funds | 17
Golden rules of portfolio building When it comes to building an investment portfolio there are some golden rules:
DO: Know what you want to achieve. Consider your objectives. Savings are for the short term, investing is for the long term.
Accept that the value of your investments will rise and fall.
Ensure your investments reflect your goals and attitude to risk. (Remember risk and return are closely linked) Research thoroughly – both before committing any money and on a frequent basis.
Review your portfolio every six months.
DON’T: Expect the best returns to come without risk. Accepting a degree of volatility is key to generating long-term returns. Be distracted by noise. Short-term market movements may be confusing but don’t let this put you off. Take past performance as a guarantee of future performance. Many investors go for the flavour of the month rather than funds with the potential for steady growth. Be tempted to risk every penny on just one area of the market. Diversification balances risk within your portfolio.
18 | The hidden costs of investing in funds
How to pick a winning investment fund Once you have a shortlist of potential funds, you should use the websites below to look at the investment track records of individual funds and managers. Ideally you want a fund and/or manager that has delivered consistently decent returns over various time periods – and that has coped in a variety of market conditions. One tip is to compare funds on their performance in different calendar years. You can then see, for example, how they have done during dire periods such as 2008 when the credit crunch bit, compared with the recovery period in 2009.
USEFUL SITES Interactive Investor http://www.iii.co.uk features news and analysis from the Money Observer and Interactive Investor editorial team, including investment tips and other portfolio ideas you might want to follow. Their discussion forums allow you to share thoughts and ideas with like-minded investors.
FE Trustnet http://www.trustnet.com – provides fund statistics allowing investors to compare the performance and attributes of different funds. It also has fund news and analysis.
Morningstar http://www.morningstar.com – pan-European equity, bond and fund statistics. It also has fund and market news and analysis.
Candid Money http://candidmoney.com/default.aspx – independent advice and fund analysis from former financial adviser Justin Modray.
Money Made Simple http://www.moneymadesimple.uk.com/ – helpful advice and contacts for those dealing with debt.
The hidden costs of investing in funds | 19
Using Advisers – when you don’t need advice: If your needs are straightforward – If you simply want to put a few pounds away for a rainy day, or make an early venture into the stock market. More and more help is springing up to ensure that non-advised investors make good choices and a little research should be all you need to save the cost of financial advice. If you are interested in money and understand the basics – Money can be fun. Once you have grasped the basics, and have an interest in how the stock market works, you should be able to build and maintain a straightforward investment portfolio that meets your needs. If you are relatively disciplined – Some people are disciplined about money. They set money aside every month; they don’t withdraw it because they fancy a holiday, and they stick to their savings plan and don’t take excessive risk. These people do not tend to need the discipline imposed by a financial adviser.
Action points
Ensure that any adviser you use is qualified to the appropriate level. They must also be qualified to give advice on your particular area. For example, they must hold investment qualifications to give investment advice. If you want top-drawer advice, look for an adviser who is qualified to level 6 or higher. See http://www.financialplanning.org.uk/
Ask whether you need fully ‘independent’ advice. Do you want your adviser to consider more esoteric investments such as venture capital trusts and structured products? Or are you happy with a portfolio of unit trusts and OEICs? How complex are your needs?
20 | The hidden costs of investing in funds
Using Advisers – when you do need advice: Lack of confidence / Lack of knowledge – There are those who simply do not feel equipped to plan their investments and they want the security of advice given by an expert. For them, that security alone may be worth the price of advice. Complex needs – There are some aspects of financial planning that are simply too complex to be attempted through a DIY approach. Trust planning, for example, would be best handled by an expert. Similarly, large portfolios, particularly those with a designated purpose, such as school or care home fees, may be best left in the hands of experts to ensure that they fulfil their requirements. Poor financial discipline – In some respects, financial advisers can act as personal trainers for your finances. They don’t necessarily do the work, but they ensure that you do the work. This means that they make sure you keep saving towards your pension, that you have money set aside for a rainy day and that you do not take financial short-cuts. One-off structuring – Many people will feel comfortable managing their investments on a day to day basis, but need some help with the early structuring of a portfolio. Once they have direct debits set up or they have handed their portfolio to an external manager (such as a discretionary fund manager), they may not need ongoing advice.
Investors can now determine whether they are getting value for money. They should be able to make a judgement on whether the advice they receive merits the fee that they pay. With the right tools, could you make the decision better yourself?
The hidden costs of investing in funds | 21
Using Advisers – keep your eyes on the ball The RDR is also aiming to build more consistency into the investment ‘outcomes’ for clients. In real terms, it means that if there is another market meltdown of the type seen in 2008, the FSA does not want to see investors accidentally holding 80% of their portfolios in equities and nursing 30-40% losses. This may sound extreme, but many funds labelled ‘cautious’ had just such an investment weighting during the crisis. This means that it wants to see more consistency around risk assessment and portfolios. In practice, this has led many advisers to outsource investment selection to a specialist such as a discretionary investment manager rather than doing the investment selection themselves. This may be appropriate for those with hundreds of thousands of pounds. However, for those simply investing into an ISA and pension, it may not be the most appropriate solution. With a small amount of research, they could do the same thing on their own account and save themselves the fees.
Action points
If your adviser has decided to outsource, ensure that you are happy with
their choice. Is it a well-known and reputable brand?
Make sure you are getting proper investment selection. If an adviser is
simply slotting you into a model portfolio, these are available on a number
of platforms.
22 | The hidden costs of investing in funds
Interactive Investor Opinion on Hidden Fees We share the FSA view that charges should be fair and transparent and that comparing charges between brokers should be easier than it currently is. Other hidden incentive payments could exist, such as those to ensure that certain funds feature prominently on ‘best buy’ lists. Customers cannot know which funds are appearing on these lists legitimately, or if they are simply receiving extra promotion. While these kinds of charges remain unknown, there is little incentive for platforms to compete on price. Like commission bias, these things may be real or perceived, but the FSA wants to ensure that it is a non-issue. The FSA has said it wants to ban these incentive-based payments, but has given no definitive time-line for doing so. In the meantime, platforms will have to reveal their charges by the end of the year. This could be bad news for some platforms. Interactive Investor does not take incentivised payments from fund providers so – unlike some other platforms – will continue to provide the transparent charging we already have in place. On a typical investment of £10,000, we pay out £64 to our customers each year. When other people talk about “rebating trail”, this often ignores the platform fee. Check if you are getting the full amount that your investment is generating.
The hidden costs of investing in funds | 23
Contact us: Website: www.iii.co.uk Email: help@iii.co.uk Telephone: 0845 88 00 267 (International: +44 1733 207555) Find out more: How to transfer your investments to us: www.iii.co.uk/fundtransfer Use our calculator to see how much you could save: www.iii.co.uk/fundcalculator This guide can also be found on our website at: www.iii.co.uk/hiddencosts The information contained in this guide is not personal advice. Before you invest it is important you understand the risks. If you are unsure about the suitability of an investment please seek independent financial advice. The price and value of investments and their income fluctuates and you may get back less than you invested. Past performance is no guarantee of future performance.
Interactive Investor Trading Limited is authorised and regulated by the Financial Conduct Authority and is a member of the London Stock Exchange. Registered office: Standon House, 21 Mansell Street, London, E1 8AA. Registered in England. Company Registration Number 3699618.