Now active funds carry a passive price

Private investors are increasingly being offered low-cost ways of investing that can shave thousands of pounds off fees over the long term.

Funds as well as managed portfolios are competing fiercely on price as investors become more aware of the impact that fees can have on their investments.

Exchange traded funds (ETFs) that offer exposure to indices such as the FTSE 100 or commodities such as gold or palladium are already popular with investors. But now active fund managers are waking up to the need to offer investors passive or low-cost solutions, as fees become a hot topic ahead of the ban on financial advisers taking commission from 2013.

This week, JPMorgan Asset Management laun-ched a low-cost, actively-managed fund that it said would challenge the passive market.

The JPM UK Active Index Plus fund will have a maximum total expense ratio (TER) of 0.55 per cent – with a base TER of 0.4 per cent then a possible further 0.15 per cent in performance fees if the fund outperforms its benchmark. Most open-ended actively-managed funds have TERs of around 1.6 per cent.

“We believe in active fund management, but it is clear that the market share for passives is growing and it’s growing quite rapidly,” says Jasper Berens, head of UK sales at JPM.

Berens points to the growing trend for advisers to tell clients to hold passives in the core of their portfolios because of their low cost, a development he says the active fund management industry has been “slow to understand”.

Low-cost fund managers have welcomed the competition. Vanguard, the US fund manager that launched passive funds in the UK charging just 0.15 per cent a year, said the move towards low-cost funds by active managers was a sign of the “positive changes” that the commission ban would bring.

Vanguard predicts that the average fund TER will soon fall from 1.6 per cent to just 0.9 per cent, once commission fees and other marketing charges are removed. TERs typically include 0.5 per cent a year that is paid to the financial adviser for ongoing investment advice.

Some financial advisers are attempting to bring down the cost of investing in other ways, by using active asset allocation of passive funds via fund platforms – dealing facilities that pool investments in one place.

Low-cost fund platforms from Hargreaves Lansdown, Cofunds and Fidelity Funds- Network are aimed at private investors who want to buy funds directly, with charges of around 1.5 per cent a year.

But most mainstream platforms do not yet offer a wide variety of investment options such as ETFs and investment trusts. Some investment managers instead use the Raymond James, Transact and Praemium platforms, which can only be accessed by financial advisers.

Alan Miller, founder of SCM Private, uses the Praemium platform to offer clients low-cost discretionary portfolio management. He argues that modern discretionary portfolios can be accessed for as little as 45 per cent of the cost of “old- fashioned” industry models, calculating that the average balanced fund charges 3.2 per cent a year once dealing costs are added in – a figure that is not normally included in the TER.

Rather than buying actively-managed funds, Miller buys ETFs to gain exposure to different asset classes and regions.

This is an increasingly popular form of investing. Justin Urquhart Stewart of Seven Investment Management calls it “asset-allocated passives”. His platform also offers investors discretionary portfolio management. The TER on the 7IM balanced portfolio is just under 0.7 per cent, while SCM Private charges fees as low as 0.5 per cent. 7IM now has such sizeable assets under management that it can cut costs further for investors by buying stocks itself to replicate an index such as the FTSE 100, rather than paying for an ETF to do the same thing.

Dennis Hall of Yellowtail Financial Planning, an independent financial adviser, uses the Raymond James platform to offer clients investment management for as little as 0.35 per cent – though a fee for advice is charged on top. Hall believes the 7IM funds make sense for clients with less than £100,000. But for those with more money, he has been buying funds from Dimensional Fund Managers, a low-cost fund manager that focuses on efficient stock trading to keep costs down, with charges of about 0.6 per cent.

Hall believes that mainstream platforms are more likely to promote active funds – which have higher charges – because the fund managers pay a commission to the platform, making them more lucrative. But advisers who use platforms can also access institutional share classes, which cut out the 0.5 per cent fee paid to the adviser and so are significantly cheaper.