An engineer and an architect invest £100,000 each in different funds that have an identical ongoing charges figure.
The funds enjoy identical returns for 30 years but when the investors withdraw their capital, the architect has £100,000 less.
What happened? This is the riddle that consumer champions and investors have been trying to solve for years.
The answer is clearer because of new European rules.
Under Mifid II, asset managers must disclose a figure for the total cost of investing.
This has highlighted the various, and often high, fees that investment houses charge on top of the ongoing charges figure (OCF), which most investors use to understand how much they pay their portfolio manager.
Mike Barrett, director of Lang Cat, says that although the costs on top of the OCF might look small initially, perhaps 30 basis points of additional charges, or 30p for £100 invested, they add up.
For example, an investor who pays a fee of 1 per cent a year on an initial investment of £100,000, and enjoys returns of 6 per cent a year over three decades, will end up with a pot of £432,194, according to Lang Cat. If, however, hidden costs add an additional 1 per cent a year in fees, that pot will be just £324,340.
“What you might see as ‘just a few basis points’ makes such a difference over the years. The numbers can be startling over time,” Mr Barrett says.
He says investors have been surprised that the true cost of investing is so much more than expected.
“Investment professionals, such as financial advisers, always knew there was this known unknown, that the OCF was not the complete picture,” he says.
“But I think it was a reasonable assumption for retail investors to make — that if an asset manager said a fund had an OCF of 22bp, that was it and that there wasn’t another 50bp on top of that.”
Under Mifid II, asset managers must provide estimations of transaction charges, which are the cost of buying and selling stocks, as well as other incidental fees. In many cases, transaction costs have been far higher than even experienced advisers expected.
For example, the Polar Capital Japan I hedged fund has an OCF of 1.35 per cent but transaction costs of 1.81 per cent, raising the cost of ownership by 134 per cent.
Iain Evans, global head of distribution at Polar Capital, says the company’s fund prices, income payments and performance figures have always been shown and paid net of all fees, including transaction costs.
“While we understand what the regulator is trying to achieve in terms of cost transparency, the net return that we deliver to our investors should be the ultimate measure of our value add,” he says.
“It is, of course, a matter of personal investor preference on the degree one is focused on the costs of a product versus the net money outcome, but we remain resolutely focused on delivering differentiated investment products and superior risk adjusted returns to our investors and believe that we can and do deliver value for money.”
JPMorgan Asset Management’s £908m European Dynamic ex-UK fund has an OCF of 93bp and reported estimated transaction costs of 1.68 per cent, lifting the ownership cost 180 per cent.
The Janus Henderson UK Absolute Return fund has an OCF of 1.06 per cent, as well as transaction costs of 79bp. If platform fees and a performance fee are charged, the total cost jumps to an average of 3.82 per cent annually if purchased via Hargreaves Lansdown, the UK fund distributor.
FE Trustnet, the data provider, created a list of 100 popular UK funds. It found that these had an average OCF of 88bp, but this jumped to 1.11 per cent once transaction costs were included.
A look at additional costs across funds in Europe shows that transaction costs added 25bp to European large-cap funds and 55bp to Asia ex-Japan equity funds, according to Morningstar, the data provider.
Funds investing in US large-caps and global large-caps had the lowest transaction costs, according to Morningstar. Funds with high transaction costs are typically those that trade more.
Investors will probably pay other fees, such as to their financial adviser or online broker.
Darius McDermott, managing director of Chelsea Financial Services, an online investor service, says the new rules reveal that hidden fees can reach “ridiculous figures”.
“There is some surprise at how much some of the charges are, especially with bigger funds where you would expect to benefit from economies of scale,” he says.
Mr McDermott says: “Clearly there was a lack of transparency” from asset managers.
He says that hidden costs are not the only aspect to which investors need to pay attention.
He points out that an investor could put their money into a fund where costs are low but performance is bad. Another investor could be in a fund with high costs and high performance and be better off.
“The charges, in some instances, are bigger than we and the public expected. But if you get good performance after charges, that is an important argument,” he says.
“It would be damaging for people to look at fees only. The cheapest doesn’t mean it is the best.”
Mr Barrett agrees that the high additional fees are not “necessarily bad”.
Several of the funds with high hidden fees performed strongly. The Polar Capital Japan I hedged fund returned 31.9 per cent in 2017, more than offsetting its fees.
JPMorgan’s Europe fund returned almost 15 per cent annualised over three years, compared with just over 13 per cent annualised for its benchmark. The Janus Henderson UK Absolute Return fund has struggled, returning just 2.7 per cent last year and 1.1 per cent the year before.
Janus Henderson declined to comment. JPMorgan said last month that a strategy that aimed for high returns, with active trading, might incur higher transaction costs. “If the sustained net return delivered more than offsets the costs incurred, those costs need to be viewed in that context,” it said.
Mr Barrett agrees that “you want your fund manager to be trading on your behalf”, but he says costs do matter.
“Hopefully, those trades work out but it is a cost and people need to understand how much they are paying,” he adds.
Nick Blake, principal at Vanguard, the world’s second-largest asset manager, says many investors will be in for a shock as more details emerge about fund fees.
Gina Miller, founding partner of SCM Direct, the wealth manager, who has lobbied for greater cost disclosure, welcomed the increased transparency but says investors are still not seeing the true figures.
“We have always been shocked at how dishonest the [asset management] industry has been about fees,” she said. “An industry that is vital from a societal perspective has chosen to act as snake oil salesmen and now they are being discovered.”
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