Break free from unfair charges

Often investors are not told the full extent of charges deducted from their investments, and can be asked to pay two or three times more than the headline costs being quoted.

However, sometimes charges are fair and investors can't expect to get something for nothing.

Advice has to be paid for and there are costs involved in investment management, and in the administration and regulatory requirements that surround the investment process.

What is particularly objectionable, however, is that consumers are only being told half-truths about the cost of investing. They are invariably being given the impression that charges are lower than they actually are.

Deductions from products and services such as investment funds, self-invested personal pensions (SIPPs) or discretionary managed portfolios are considerably higher than investors are led to believe.

This situation must change. Investors must be told the full impact of all charges involved in the investment process. Transparency is essential for investors to make informed and rational decisions.

New regulations

Financial regulation has started to toughen up in some crucial areas. One of the greatest areas of controversy has been the commission paid to financial advisers by product providers.

Ostensibly it was to remunerate advisers for the time and effort involved in examining investors' needs and recommending the right products.

In reality, recommendations of less-than-scrupulous independent financial advisers have clearly been influenced by the amounts of initial commission paid on different products and by different product providers.

A prime example is the widespread selling of insurance company investment bonds, with initial commissions of up to 8% in some cases, in preference to investment funds paying commission of 3% or investment trusts that pay no commission.

Higher-commission SIPPs (comprehensive SIPPs) have also been sold instead of low-cost stakeholder pensions.

As long as commission continues to be paid for out of product charges, some investors will not be aware of how much they are paying advisers, nor that they are paying for ongoing advice they do not receive.

At the end of March, the Financial Services Authority (FSA) published its latest proposals under the retail distribution review (RDR) reforms for a system of 'adviser charging', to be implemented by 2012.

It will require advisers to operate their own charging tariffs to be agreed with investors in advance. These charges have to reflect the actual services provided by advisers.

Consumer groups welcomed the FSA's proposals, particularly the fact that they will remove product bias from advisers' recommendations and underline that IFAs are working for the investor rather than the product provider.

However, as IFAs start to become fee-based, and extend their areas of expertise, it is important that the impact of other costs that adviser firms may levy is also made crystal clear to investors.

Generating revenue

Advisers and stockbrokers who offer discretionary wealth management services have a tendency to levy stealth charges to generate extra income.

These include bumping up dealing commissions, dealing excessively to generate extra revenue, not passing on all the interest earned on cash deposits and charging for tax calculations and other services.

These charges, in addition to the adviser's management fee of, say, 1% per year, can add an estimated 1% or 2% to investors' annual charges.

In addition, the FSA has yet to turn its attention to the pricing practices of UK investment fund managers, although these matters are under review at the European level.

Almost without exception, asset management companies are claiming their charges are one amount and then deducting more.

The annual management charge quoted in marketing literature frequently bears little relation to the actual deductions made from investors' holdings.

It should therefore be obligatory for all asset managers to display prominently the total expense ratios (TERs) of their funds as opposed to just the annual management charges.

The TER is a consistent measure of all the operating costs that drag on fund performance each year, including administration, custody, audit, management and distribution fees, although it does not currently include portfolio turnover costs.

Urgent action is also needed to highlight the effects of the insidious spread of performance fees on investment funds, fuelled by a recent surge in the launches of absolute return funds, which is making a bad situation worse.

The imposition of performance fees is enabling managers to double or treble the charges they take from investors when they exceed an arbitrary short-term performance target, even though these are the returns that investors could fairly expect for the basic management fee.

Among the problems associated with performance fees is that there are no standard benchmarks or parameters for them, which makes it impossible for investors to make comparisons. What's more, investors are not recompensed for poor results.

As David Norman, managing director of TCF Fund Managers, a new low-cost fund provider, says: "Performance fees would be great if they worked both ways: paying refunds for underperformance."

But there are signs that some members of the financial services establishment realise they cannot go on ripping off investors.

TCF, for example, which was founded by two former directors from conventional asset management companies, is starting to offer a number of risk-rated, mixed-asset funds investing in low-cost exchange traded funds with TERs of less than 1%.

For investors, with a period of less buoyant growth ahead in the aftermath of the financial crisis, the message is to be less trusting about charges, and where expenses are unjustified to vote with their feet by switching to lower-cost options.

This article was originally published in Money Observer - Moneywise's sister publication - in May 2010

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