Usually, it is advised to look at the total expense ratio (TER) of a fund, which tots up all the various charges and shows how much you’re paying in fees overall.
But new research suggests that even TERs don’t show the whole story.
Spencer-Churchill Miller Private (a wealth management firm set up earlier this year by the previous chief investment officer of the now defunct New Star Asset Management, which has been bought by Henderson) reckons that investors could be paying up to £5.8bn a year in annual ‘hidden’ charges – and that’s on top of the normal TER.
They say that because TERs don’t include things like dealing commissions, taxes and interest on borrowing, investors often aren’t getting the whole story.
For example, the average TER for an open-ended fund in the UK All Companies sector is around 1.6 per cent – but add in these extra charges and the annual cost could be up to 2.8 per cent.
How much churning fund managers do in their portfolio is also relevant. Some managers buy and hold value stocks, others try to play the markets a bit more. But this can be costly – SCM reckons the typical fund manager turns over about 57 per cent of their portfolio each year, adding another 1 per cent a year to charges.
So SCM Private is proposing a new calculation – the total cost of investment ratio – that would include all these costs too. This probably won’t become the industry standard any time soon, though, but in the meantime investors can have a think about existing TERs.
Basically, it’s difficult to know whether you should be paying a fund manager at all to select stocks, when so many of them end up sticking pretty close to the index anyway for fear of underperforming their benchmark.
There’s growing interest in passive funds for precisely this reason – such as exchange traded funds, which charge a TER of 0.15 to 0.5 per cent and have been flying off the shelves in the past couple of years.
Still, if you believe in the power of the fund manager to add value, some funds are cheaper than others. Open-ended funds usually have TERs of above 1.5 per cent – but closed-ended funds, aka investment trusts, have average TERs of just 1.39 per cent – and the bigger ones have charges less than 1 per cent.
So heads up people, those charges can have a big impact on performance over the longer term…