The benefits of all-inclusive fund management fees
There are no hidden fees in the fund management industry. Its critics keep going on about them, but they also "fail to identify conclusive signs of their existence". And that is because they don't exist. They are not "lurking within". They are instead the "Loch Ness Monster of investments", a figment of the imagination of financial journalists and over-feisty challenger businesses. That, at least, is the (firm) view of the industry-cheerleading Investment Association, which released a report on the matter over the summer. Is the IA right?
The analysis in its report — which attempts to show that not only are there no hidden costs but that even if there were, active funds outperform enough to compensate for those costs — is pretty ropey.
But it is really a matter of definitions. It's not that charges are hidden, it's that they may be disclosed, but not obviously (accountancy fees, depository fees, custodian fees, external research costs). In other cases they are unknown, hence tricky to disclose.
Transaction costs (commission plus stamp duty and the cost inherent in bid-offer spreads) are the main culprits here. A manager can't know in advance how much he will trade and in what volumes, so he can't tell you on 1 January how much he will have charged you for his trading over the year until 31 December.
I've been trying to think of any other sector that works like this — where you buy a thing but are then hit with obligatory costs you can't know in advance. You could compare fund pricing to aviation pricing. A report from the Civil Aviation Authority this week pointed out that some 43% of their revenues (on Jet2.com it is £39 per passenger, for example) now come from additional fees, "or ancillary revenue" as the airlines like to put it, that are not included in the headline ticket prices.
Consider credit card booking fees, checked luggage fees, charges to book a seat and so on. These aren't hidden fees: you can find them reasonably clearly noted on most websites and they aren't always unreasonable. EasyJet charges you £80 to rebook if you miss your departure, for example.
But, like fund management costs, they aren't particularly transparent either. However, they aren't quite the same thing, simply because they aren't ongoing charges. They are services you can choose to have or not to have.
Fund managers (and maybe governments) are the only group of service providers that can headline with one price, but announce some time later that the actual price was different (often double the original price) and that they have removed the difference from your account (over which they have full control). They get to tell you the predictable bit, but leave all the risk in the less predictable bits on your plate.
This is no good at all. That you never know what you will have to pay is one irritant, of course. But the other is that it remains very hard for investors to compare the cost of one fund with that of another.
Over the years I have suggested various ways of dealing with the problem of how investors are charged for funds. I thought it would be a good idea for funds to charge flat absolute fees, for example. Charging a percentage of assets just encourages asset gathering at the expense of good performance.
And I'm all for exploring how a very low absolute management fee could be combined with a performance sharing system for management and investors. But as I am not getting quite as much traction on this as I think I should be, I'd like to suggest an interim solution: the all-inclusive fund management fee.
Under this system, fund managers would be obliged to behave in the same way as travel agents offering genuinely all-inclusive holidays. They announce a price at the beginning and that is that. The price includes everything: management costs, all fees and commissions, all research and all trading costs.
Those costs may fluctuate across the year. They may be higher than the fund management company expects or they may be lower. But that's a problem for the firm not for the investor, just as the fluctuating costs of jet fuel and cheap prosecco are problems for Thomas Cook rather than for the prepaying punter.
The benefits of shifting to a system like this are obvious. First, it offers full clarity to the investor: all-in prices mean they can compare like with like. Second, it firmly forces the providers to explain why their costs are what they are. If they want to charge more for a fund that has high turnover they will be obliged to explain why they consider, for example, high turnover of investments to be a good thing (when it almost invariably isn't).
Third, it might lead to a reappraisal of costs across the board. If the fee is all-inclusive, the incentive to push costs down is high. So we might find fund managers looking for all-inclusive annual trading deals (a flat fee!) from their brokers or pushing down their legal and accountancy fees to levels those in non-financial industries might think reasonable.
This isn't a perfect solution to the problem of fees (the whole percentage charging thing will still be with us). But it would, I think, be an excellent way of beginning to make fund managers think and behave more like the providers of other services, which in turn would start to create real competition — and bring down the costs of investing. And that of course is the thing that matters almost more than anything else to our ageing, saving population: the less we pay away in costs, the more we will have to live on in our old age.
This article was first published in the Financial Times.