A drum that we have been banging for the last twelve years at Manse is finally being heard in the larger arena of the financial services industry and the associated press that writes for it.
Recently, The Financial Times “FT Money” section ran an article on probably the most important yet deliberately opaque aspect of investing money in this country, “Hidden Costs That Eat Away at the Value of Your Portfolio” by Norma Cohen.
It outlined research from various institutions that had looked carefully at the investment charges that are never declared to the investor. It is worth remembering that all charges that are applied to an investment portfolio will reduce the returns to investors, and the size of these hidden charges may be responsible for at least 30% of the cost of running a pension or investment fund.
These hidden charges are on top of the declared charges that you are told about which the FT article estimates at 2.5% pa. This is made up of Platform fees 0.35%, Fund Managers charges 0.75%, Other charges 0.58% and Advice costs 0.82%. (Source: True and Fair; Fitz Partners; Centre for Policy Studies)
So where do these hidden charges go and what are they for you may well ask? Before we answer this question let us clear up one huge misunderstanding that is prevalent across pretty much all of the British public and frighteningly enough, a lot of financial advisers, stock brokers and wealth managers.
The misunderstanding the industry wants you to believe
This misunderstanding is that the quoted figures for the Annual Management Charges (AMC), Total Expenses Ration (TER) or the Ongoing Charges Figure (OCF) that appear in all fund literature include all the charges associated with running the investment funds you place your money in to. THEY DO NOT.
They exclude the costs of trading known as “transaction costs” that are generated when the fund manager buys and sells shares, bonds or other assets within the investment funds. Taking that an active fund manager’s job is to trade assets to try and beat the market then clearly these costs will be significant.
So what are these Costs?
Defining then absolutely is a challenge but they fit generally in to two classes, explicit costs and implicit costs.
The Explicit costs can be defined but not so easily calculated and include things such as stamp duty, exchange fees and brokerage commissions. The difficult one here is brokerage commissions as these pay for not only the costs of buying and selling the assets but also a raft of far more “nefarious” costs that are often labelled as “research” or “access to corporate clients”. For these you can read expensive golf days or trips to Twickenham to watch the rugby. In all other industries these would be known as “inducements” or more honestly bribes.
The implicit Costs are not only harder to define but also harder to measure yet can be far more destructive to your portfolio than the explicit costs. Yossi Brandes, head of European analytics research at ITG, a company that specialises in measuring then said “It’s not talked about much, but implicit costs can be more significant than explicit costs”
They are complex but broadly they occur due to the difference in price that exists between the value of share, bond, traded fund or asset when the order to trade is given and the price that it is actually traded at. This change that occurs over the course of fulfilling the order is known as the “implementation shortfall”. This is very difficult to measure and predict as it depends on how big the order is and what type of assets are being traded. A large trade of very liquid shares such as FTSE 100 stocks will in itself create a price movement of the asset simply through the action of trading, but so will a relatively small trade of a ‘micro cap’ stock due to the lack of liquidity (small number available in the market).
So what does all this mean and how can I avoid these Costs?
The FT article concurs with our own research and the story we have been telling clients for over 10 years, the more your fund managers trade the more it costs you. The combined costs of the hidden explicit and implicit fees talked above can be brought together under the title of “Portfolio Turnover”. The higher the portfolio turnover of a fund, the greater these costs. The research shows that UK large cap funds with a portfolio turnover of 50% (i.e 50% of the value of its total assets are traded each year by the fund managers) will cost you an extra 0.9% a year in charges. If they have a portfolio turnover of 100% this figure rises to 1.8%.
Remember these are only the hidden costs. The FT article then makes it clear that if you then add back in the average declared costs that you pay for investing of 2.5% as detailed above, your total costs can rise easily to over 4% or more. This is a massive amount of money to give away and has a huge impact on your long term returns.
So how can you avoid it? The answer is simple, use institutional investment funds which have much lower charges than retail investments funds and use a passive investment strategy. This ensures that you do not employ the use of an active fund manager whose job it is to trade frequently and go on expensive’ beano’s’ at your expense.
But of course as long term clients you already know all of this, as Manse Capital has been running these portfolios for over 11 years now and they have proved very successful in delivering the returns for clients based on the degree of risk they are prepared to take even during the testing investment landscape of the last 8 years.
If you have friends, relatives or colleagues who would like to significantly cut the costs of their own investing and stop paying for expensive away days for the boys and girls in the City then please get in touch.
Finally, it is excellent to see that at last there is sufficient pressure being placed on the industry to warrant the FT to run articles on this subject, the more people know about it the lower the cost swill have to go and the better the outcome for the investor.
Source Financial Times, FT Money Section Saturday 7th June 2014. Norma Cohen. Hidden Costs FT Article from Gulf News pdf