Last time we looked at the fees and charges that UK consumers pay to invest, and how it’s almost impossible — for financial professionals, let alone ordinary investors — to work out a total amount.
Dr Christopher Sier, a professor at Newcastle University Business School has researched this issue for many years, and calculates that the Total Cost of Ownership (TCO) for an actively managed UK equity fund is an eye-watering 3.1%, or 310 basis points.
Here are five other lessons to learn from Dr Sier’s research.
Economies of scale are not being passed on to consumers
In a competitive market, costs are supposed to come down. But, over the years, the cost of investing has actually gone up. Because fees are largely based on how much money they manage, fund managers are rewarded not for the value they add but the amount of assets they gather. Total AuM in the UK rose from around £3 trillion in 2009 to £5.5 trillion in 2014. But that hasn’t translated into lower fees. In fact, a survey by Lipper in 2011 showed that when fees change, 90% of the time they rise rather than fall.
Investors overseas HAVE benefited from economies of scale
Data from Morningstar shows that investors in France, Germany and the US generally pay less in fees the larger a fund becomes. In Germany, for example, in 2010, investors paid an average Total Expense Ratio (not to be confused with TCO) of 1.73% for funds of less than $75 million pounds in size, but just 1.37% for funds bigger than $1 billion. By contrast, UK investors in the largest funds paid more, i.e. 1.67%, than those in funds with fewer than $1 billion in assets, who paid 1.65%.
Intermediation and complexity have driven costs upward
As I mentioned earlier, fund managers are primarily rewarded for attracting assets and, in Dr Sier’s view, the way to do that is to conceive ever more complex products. By their nature, complex products require complex processing and more manpower to manage, and the rush to be first to market can also overpower standardisation of operations. And, of course, trading itself comes at a cost — custodians, fund administrators, brokers, clearing houses and exchanges all need to be paid.
Conflicts of interest can also add to the cost
Dr Sier’s research also points to an agency problem in UK asset management. An example of a conflict of interest is the fact that fund managers need to trade more to justify their value, although all the evidence shows that, generally speaking, the less trading they do the better. Another concern that Dr Sier has is that fund houses may have a financial incentive to encourage more trading, with so-called soft commissions allowing firms to move costs from one Profit and Loss account to another.
UK funds have a big survivorship issue
It’s a well-known trick of the trade that fund houses like to make their performance figures look better than they really are by 1. constantly launching new funds and 2. steadily closing or merging funds that consistently lag the market. It happens all over the world but, as Dr Sier points out, the practice is particularly rife in the UK. According to data from S&P Dow Jones Indices, for example, 55% of UK equity funds available ten years ago performed so poorly that they no longer exist. Survivorship rates for UK-domiciled funds in other sectors, including US equities and European equities, were even lower.
The third and final part of this series will feature a video interview with Dr Sier. In it he highlights one way in which fund managers could significantly reduce their overheads and the cost of investing at a stroke — namely by paying themselves more realistic salaries.
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