Where does the money go? It is not clear how commissions are made up
Experimental feature

Listen to this article

Experimental feature

UK-based fund managers may be offloading £1bn of costs a year by bundling them up in opaque client commissions, according to estimates based on analysis of a sample of funds.

The figure could include payments for corporate access, which are against Financial Services Authority rules, as well as third-party research, which is permitted by the FSA but which some industry figures argue should be paid by the asset manager out of a fund’s headline annual management charge.

Asset managers with large teams of in-house analysts bear the costs out of their own pocket, but houses that essentially outsource their research function to sellside analysts are able to use their clients’ money to cover the cost.

“Members of the IMA [Investment Management Association], managing funds from the UK, including everything from unit trusts to pension funds, appear to be paying at least £1bn a year in relation to research services which have been ‘bundled’ into the overall commissions and which very few clients would be aware of,” said Alan Miller, founding partner and chief investment officer of SCM Private, a London-based investment manager, who collated the figures.

“The scandal is that investors may think these costs are included in the AMC as, after all, this research is an element you would have thought is an essential part of a fund manager’s job. So in essence the investor is paying twice.

“Fund managers are having their own costs subsidised to the tune of millions of pounds.”

The analysis comes days after the FSA said it was preparing a crackdown after discovering some asset managers were spending “tens of millions of pounds” of client money a year on corporate access, amid reports that investment banks sometimes charge fund managers up to $20,000 an hour to meet the chief executives of their corporate clients.

Mr Miller, a leading campaigner for transparent fund charges, analysed the report and accounts of the 34 largest actively managed and passively managed UK equity funds, as well as a selection of major European equity funds.

Large UK equity funds (Highest payers of commission as proportion of purchases and sales)
FundFund size (£bn)Purchases and sales (£m)Commissions (£m)Commission divided by purchases and sales (basis points)
Axa Framlington UK Select Opportunities3.51640.21.2119.0
Invesco Perpetual Income9.512,400.33.7415.6
JO Hambro Capital Mng UK Equity Income1.621,205.71.8715.5
Schroder UK Mid 2501.37470.20.7215.3
Artemis Income5.013,179.14.4914.1
Sources: SCM Private; company accounts

He found passive UK equity funds, which do not pay for research or corporate access, typically pay commission equal to 2.1 basis points of the securities they buy and sell, suggesting this is the unavoidable cost of executing trades.

The largest active UK equity managers paid a commission rate of 10.4bp, on average, suggesting that 8.3bp of this was for research and other costs. For European equity funds the gulf was wider, at 9.9bp.

Adjusting for the lower than average turnover of these large funds, a disproportionately large number of which are passive index-trackers, and applying this figure to the £1.76tn of equities managed in everything from unit trusts to pension funds by IMA member asset managers, Mr Miller estimated the overall level of client commission at £1.36bn. More than £1bn of this would appear to be for research and other expenses.

Mick McAteer, chair of the European Commission’s financial services users group, argued these costs should “come out of the fund manager’s pocket”, not that of clients.

“If they are setting themselves up as an active manager who knows the market and that is their main investment proposition, then the whole research function should be part of that,” Mr McAteer said. “It’s very hard to justify that coming out of clients’ money, particularly when you look at the performance of active funds. It’s about transparency.”

Daniel Godfrey, chief executive of the IMA, said payment for research from commissions was “not wrong per se” and was disclosed to investors. Moreover, investors could end up paying more if the costs were transferred to the AMC, which rises in line with the value of the fund, he argued.

However Mr Godfrey acknowledged commission payments did “add a layer of complexity” and said “the IMA wants to look at this over the course of the year to see if there is a better way of doing things”.

Among the large UK equity funds analysed by Mr Miller, the Axa Framlington UK Select Opportunities fund had the highest ratio of commission to purchases and sales, at 19bp, far higher than the 3.6bp of M&G Recovery, the lowest figure for an actively managed fund.

Mark Beveridge, global head of Axa Framlington, said: “We can confirm that we are completely transparent in the disclosures we make in relation to the use of commissions and this is outlined in the disclosures that we share with fund trustees and depositories. We welcome and support the FSA’s ongoing dialogue with the industry on this topic.”

Next highest, according to Mr Miller’s analysis, were Invesco Perpetual Income (15.6bp), JO Hambro Capital Management UK Equity Income (15.5bp), Schroder UK Mid 250 (15.3bp) and Artemis Income (14.1bp).

A spokeswoman for JO Hambro labelled the calculation “simplistic …and not an appropriate indicator of research or other costs”. She said 2bp underestimated its fund’s execution costs because it invested heavily in small and mid-cap stocks that are more expensive to trade. She said there was “broadly a 50/50 split” between execution and research costs in its commission payments, that it did not pay for corporate access and that the fund’s performance is top decile over one year, five years and since launch in 2004.

Ross Leckie, director of communications at Artemis, said: “Research and execution services are legitimate uses of broker commissions. We review our spending regularly in both areas to ensure we are getting value for money for our clients. “We do not pay for data or corporate access from commissions. Meanwhile, it’s worth remembering that that commission rates only tell part of all the story. High levels of fund turnover can be much more costly. In general, the direction of travel on commissions is clear. We welcome that.”

Invesco Perpetual and Schroders both declined to comment.

Get alerts on Fund management when a new story is published

Copyright The Financial Times Limited 2019. All rights reserved.

Follow the topics in this article