Why 2013 has already been a great year for investors
Investment advice from Merryn Somerset Webb
The year 2013 might not turn out to be a great year for investment returns – equities aren’t particularly cheap and bonds are ludicrously expensive. But it has already been a great year for investors. Why? The Retail Distribution Review, or RDR. This new set of regulations came into effect on January 1. Among other things, they ban independent financial advisers (IFAs) from taking (and financial companies from paying) commissions when you invest in financial products. The upshot is that every time you buy a fund, open an individual savings account (ISA) or set up a pension, you will know exactly what you have paid your IFA to help you do so.
The difference is not that you are paying for advice (you have always paid) – it is that the money is no longer taken from your investment by the fund manager, and then returned to your IFA. Instead, it is paid by you to your IFA directly. It is all about transparency.
So how, you might wonder, does it help you to pay like this? First, it should improve the integrity of your investments. If your adviser can’t take commission, he can’t indulge in commission bias (suggesting you buy the investments that pay the best rates of commission rather than just the best ones). That’s already happening – there has been a huge rise in interest from advisers in investment trusts, which are generally cheaper than unit trusts and offer better long-term performance, but which don’t pay commission.
Second, it should push down prices across the board. That’s already happening too. Until RDR, it was accepted that an average investment fund should cost something in the region of 1.5% of the value of the assets held within it on an annual basis. Post-RDR, it has become clear that this 1.5% wasn’t just about the fund manager – a good third of it was being paid back to advisers. That would have been fine, except for the fact that the funds charged the same price to ordinary investors who weren’t using advisers.
Now, the big fund managers have mostly come out with what they call ‘clean’ prices – prices with the old adviser payment cut out. And they are a whole lot cheaper. Baillie Gifford – a Scotland-based mega manager – has, for example, cut the clean fees on all of its unit trusts down to 0.65%, while 0.75% looks like it will soon be the new standard across the industry.
This is all good news. But as is always the way with the financial industry, it isn’t as straightforward as it should be. Why? Firstly, because the management fee isn’t the only cost with a fund and, as The Sunday Telegraph points out, fund managers are very good at “manipulating their charges so that investors end up paying far more than the advertised fees”. Trading fees and broker commissions are not included in either the calculations of the annual management charge (AMC) or the wider total expense ratio (TER), for example. This matters, as both can be very high – the average actively managed fund adds another 1% a year or so in trading costs.
It also matters because, via a practice known as ‘softing’, funds often pay more commission than necessary to brokers to cover the costs of research and so on. You might think that the costs of research should be in the AMC. You’d be right. But that doesn’t make it so – funds that want to keep headline fees low don’t always follow the moral guidelines investors think they should. But the fact that the fees aren’t always entirely honest isn’t the end of it, because very often the clean fees are only available if you buy your funds via an IFA. Buy them elsewhere, and you will pay more. The platforms through which most of us buy our funds are still allowed to receive trail commission from the fund management companies – that won’t end until next year at the earliest.
The RDR has been a fantastic thing for transparency – and it is really rather thrilling to see it shaking up the industry. But regular readers will know that the financial industry doesn’t take threats to its super-profitability lying down – it always has a plan. So what do you do? You can avoid the entire issue by investing in investment trusts rather than unit trusts (see www.moneyweek.com for our core portfolio suggestions). You can buy individual shares (if you can be bothered with the research). And you can buy clean funds via a cheap transparent adviser.
But the most important thing you can do for yourself is to keep asking questions. The more often you ask about how much your investments are costing, and the extent to which you are getting value from them (and the manager looking after them), the better.
For more from Merryn, see www.moneyweek.com/blog.