We love a bargain… We drive several miles out of our way to save a penny on a litre of petrol. We collect vouchers to save a few pence on grocery items. And we grumble when the Government slaps another penny in tax on a pint of beer.
And yet, when it comes to our pensions, one of the biggest financial investments we’ll ever make - often the biggest - we either don’t know what we’re paying or don’t even seem to care.
One explanation is that when you start a pension, retirement is so far off you’re not too concerned about the impact of charges on an investment you might not need for another 40 years. But another problem, at least here in the UK, is that charges are complicated and not always easy to calculate.
The True and Fair Campaign, which lobbies for fairer and more transparent charges, accuses the industry of using smoke-and-mirror tactics.
Campaign founder Gina Miller says: “The fund management industry is supposed to publish something called the ongoing charge. That was under an EU directive that came in in 2012. Most companies still only publish the annual management charge. Outside of that annual management charge there can be a myriad of other charges, between 11 and 13 layers. You've got jurisdiction fees, you've got bid offer spread, you've got administration fees, you've got taxes, stamp duty. In a way though, it doesn't really matter what all these charges are. It’s not up to the individual investor to have to become a detective to find out those charges. It should be the industry doing the work to put that all in an understandable number into a ticket price. When you buy a car, you don’t expect to see a list of how much the wheels cost or the engine. What you expect to see is how much the car is going to cost you.”
What we’ve seen in recent years is an “unbundling” of charges. The different fees applied now need to be broken down. That’s improved transparency, but it’s also added to the complexity. Unbundling has also made it look as though charges have gone down, when in many cases they’ve risen since the regulations came in.
Under the old system, annual charges were usually around 1.5%. But fund managers would pay some of that to third parties such as fund platforms or financial advisers.
Now, although fund management companies typically charge a more modest-sounding 1% or 0.75%, they keep all that for themselves. In fact many funds are pocketing more in charges than ever before. And because there are still separate fees to pay on top of the management charge, investors are often worse off.
And of course, all that’s before trading costs. Research suggests that many fund managers have responded to regulatory pressure to reduce annual management charges by simply trading more and charging for it, in order to maintain their profit margins.
The combination of trading costs and the compounding effect of annual charges can take a very large chunk out of the average pension pot - even in America, where overall investment costs are significantly lower than in the UK.
Nobel Prize-winning economist Eugene Fama says: “If you’re paying management fees, the cumulative effect of that, given the way compounding works, is enormous. So active managers basically charge on average 1% in the US on management fees and you never know what their transactions costs are, because that's not a reported number, but they've gotta be way higher than for passive managers because they're going in and out of securities all the time.”
As well as resisting calls to reduce their charges, fund managers have been accused by some of acting almost like a cartel.
One survey found that 68% of the UK’s largest retail fund sector charged an identical fee.
Mark Dampier of Hargreaves Lansdown says: "I think it's a fair point, it is very strange that most of the industry prices at the same point, because what are you pricing for? Expertise. So, surely you would expect someone with superb expertise and great fund management to actually charge more than someone who’s not done so well, but I don’t think the industry has got into that competition mode. So, I wouldn't go as far as a cartel, I don't think that's true, but a cosy club, well, maybe."
Another trend that some have observed is the growing number of funds that claim to be actively managed, but in fact are virtually passive - in other words, they broadly track the entire index. Passive funds are cheaper to operate than active and should therefore have lower charges.
Merryn Somerset Webb, Editor-in-Chief of MoneyWeek, says: “Almost all fund management is a complete rip-off. I mean, we know that. We only have to look at the prices relative to the performance. You take a fund and you look at its top 10 or top 20 holdings, and you’ll see that they’re exactly the same as the top 10 or top 20 holdings in a passive fund. So there’s a huge, huge market out there full of active funds that are not actually active at all, or if they are active this is a very strange definition of active because they’re knocking around at any old benchmark.”
So what sort of impact do charges have on the value of our long-term investments?
Well, over 40 years, a pension fund worth almost £250,000 with no charges would be reduced to just £174,556 with an annual charge of 1.5%.
If overall charges reach 2.5% - and when trading costs are included, that’s not uncommon - this reduces the value of the fund to less than £140,000.
So, even at 1.5 percent, almost a third of your fund is lost in fees, rising to almost half when charges increase by 1 percentage point.
The True and Fair Campaign says fund managers are taking far too much out of people’s savings and they could easily afford to lower their charges.
It says inefficiencies are rife and, although the industry has grown, there’s been little or no attempt to pass on economies of scale to the consumer.
Gina Miller says: “Well the average UK small to medium size business is making between 9% and 15% profit - somewhere around there. The average UK fund management in business is making 30% profit. Those figures speak for themselves. They’re growing fat and rich, while the consumer is losing out. The very people who are being prudent and saving and investing are not the ones who are retiring with a comfortable pot. It’s the fund managers who are becoming millionaires and billionaires because of those profit margins.”
Next time on How to Win the Loser’s Game.
Founder of the Vanguard Group John Bogle says: “Probably about 1% of managers can read the market over the very long term”
Former active fund manager Alan Miller says: “The bigger the institution, the bigger the brand normally the more you pay, and normally the worse the performance”
Public policy adviser Michael Johnson says: “Virtually for all investors, making a decision as to which active funds to invest in is a pure lottery”