If you look at the majority of posters on the tube or on the sides of taxis promoting fund ranges, more often than not they’ll quote an annual management charge (AMC), and that’s about it. For actively managed funds, this tends to range anywhere from 0.25 and 1.5 per cent.
While no doubt accurate, the AMC does not tell the investor exactly what they’re paying for the pleasure of owning a fund. There are various bodies campaigning to make fund charges more transparent, which would make it obligatory for investors to be told in pounds and pence precisely how much they’re paying in charges.
However, for the time being at least, you’re on your own.
Here, we try and cipher through all the terminology and highlight what cost-conscious investors need to know.
Ongoing charges figure (OCF)
While by no means perfect, a much fairer reflection of what an investor pays is the ongoing charges figure, commonly known as the OCF. This replaced the total expense ratio (TER) as an industry standard last year.
This figure encapsulates the AMC, as well as the various admin costs that go along with running a fund. For example: trustee fees, audit fees, regulator fees and most notably, trading costs.
The problem with this measure is that it’s backward-looking, telling an investor how much they would have paid over the 12-month period previously. However, if the fund manager trades more actively in the corresponding year, the fee the investor pays is likely to be significantly higher.
This is especially pertinent if a fund has been recently taken over by a new manager, who is likely to incur much higher trading costs while overhauling the portfolio. FE Alpha Manager Julie Dean decided to waive the 0.5 per cent AMC on the Schroder UK Growth trust for this very reason very recently, but not all managers are quite so receptive.
"The difference more or less trading has on the cost of the fund differs between asset classes," said Gavin Haynes (pictured), managing director at Whitechurch. "It’s likely to be quite muted if it’s a blue chip equity fund, but much higher if a property manager is trading frequently," he added.
Performance fees
This is perhaps the most controversial of all the extra charges installed by fund groups.
Many private investors tend to associate performance fees with hedge funds, but a number of open-ended funds and investment trusts also implement these extra charges.
The idea makes sense in layman terms, in that it rewards fund managers for beating their benchmark. This, Haynes says, is reasonable, as long as the manager is also punished for not beating their benchmark.
"It’s amazing, because some managers will look to be rewarded for outperforming but won’t be willing to give some of their fee back if they don’t perform well," he said.
"For this to happen, the other charges need to be under average."
Groups such as JO Hambro charge significantly lower OCFs to compensate for their use of performance fees, but others do not.
Absolute return funds have come under particular criticism for charging performance fees. The likes of Jupiter Absolute Return, which has an OCF of 1.48 per cent, charges 15 per cent of everything returned in excess of the LIBOR GBP 3 month index, annually.
The issue is so controversial because the impact performance fees have on overall costs is so great. Research from the Association of Investment Companies (AIC) reveals that the impact can be up to a whole percentage point over a single year.
The Scottish Oriental Smaller Companies IT's OCF is 1.01 per cent for the last year, but if performance fees are included, the figure jumps to 1.96 per cent.
The other issue with performance fees is the benchmarks that are used to calculate them. In an interview with FE Trustnet last year, Hargreaves Lansdown’s Mark Dampier said he took exception to funds that use cash plus-benchmarks, even though they focus on high growth areas such as emerging markets or commodities.
First State recently admitted that the performance fee benchmark it uses for its Scottish Oriental Smaller Companies IT is "far from ideal".
Stamp duty
When investing in funds, stamp duty is included within the OCF; however, anyone invested in listed shares – including investment trusts and ETFs – has to pay the 0.5 per cent rate up front.
Asset managers will be exempt from paying stamp duty on shares from April 2014 in new controversial legislation, and stamp duty on AIM-listed stocks is set to be abolished this autumn.
Broker fees
There are extra stockbroker fees charged to investors holding listed equities, including investment trusts and ETFs, that aren’t applicable to open-ended funds.
Typically, for any transaction involving a listed equity, investors must pay a commission of between £7 and £15 to the broker.
While this may not sound like a great deal, if you’re working with relatively small amounts of money this can make a massive impact on the percentage you’re paying.
For example: if you decide to put £1,000 into a racy investment trust and have to pay £10 in commission for the pleasure, you’re adding an extra 1 per cent on top of the OCF you’re being charged. For those who actively trade, the compounding effect of these commission payments can be very significant indeed.
Platform fees
Investors also have to pay platform fees depending on their provider, and custody fees on top of that, as Bestinvest’s Jason Hollands explains: "This is a flat fee for the administration of holding securities on a platform."
"It’s not charged for each individual holding, but for a group. It depends on what the platform charges, but you’d be looking at £12.50 a quarter for an account."
Depending on the platforms you are using, investors can also be charged for switching their investments from one provider to another.
Others charge investors for making transactions, though this is becoming increasingly rare. Hollands says some platforms may re-introduce these fees following changes in regulations next year.
Entry/exit charges
Entry and exit charges have been all but wiped out by platforms, though they’re still applied to investors in some cases if they go directly through a fund group.
Initial charges are most relevant when discussed as a mechanism for soft-closures. If a fund group deems a vehicle to have become too big, it may impose an initial charge to discourage new investors from buying it.
However, as they remain open to investors, some investors may find themselves adding a fund that charges an initial fee of anything up to 5 per cent. A good example of this is the popular Aberdeen Emerging Markets fund, which charges an entry fee of 2 per cent.
Panel of takeover and mergers (PTM) levy
For the big spenders among you who like to invest in listed equities including ETFs and investment trusts, there’s an extra charge you need to know about.
The PTM levy is a charge automatically imposed on investors, and collected by their brokers, when they sell or buy shares with an aggregate value in excess of £10,000. The charge is £1, and the money raised goes to the panel of takeovers and mergers.
It’s certainly not a huge amount, but every little helps…
