What you see is not always what you pay

What you see is not always what you pay

One of the most popular methods of saving is through investment funds such as unit trusts, open-ended investment companies (Oeics) or investment trusts held in Isas or pensions. Yet few investors know their true annual charges. Although rules were introduced last year forcing investment groups to publish all deductions, known as total expense ratios (TERs), these are usually buried in the small print of their brochures.

Companies highlight the annual management charges on their funds, typically around 1.5 per cent, whereas the actual annual cost, the TER, can be up to twice that. Multi-manager funds, which invest in other managers' funds, tend to be particularly expensive.

Since last October, the Financial Services Authority has made it compulsory for fund management companies to publish TERs in the 'key features' documents given to investors when they first invest. But financial advisers say few people bother to read these small-print documents. Justin Modray of independent financial adviser Bestinvest says: 'A typical investor is more likely to look at the fund fact sheets and marketing brochures, but these continue to show annual management charges only. Investors should know how much they are really paying, so every time the annual management charge is given, the TER should be shown alongside.'

Advertisement starts

---

---

Advertisement ends

Differences between annual management charges and TERs vary significantly, from an additional 0.05 to over 1.5 per cent. Some exceed 3 per cent. The reason given is that the annual management charge only covers the investment manager's fee, whereas the TER includes additional costs such as the fees paid to the trustee, custodian, auditors and registrars. But some funds have considerably higher TERs than others.

There may be an explanation for this. Ed Moisson, director of Lipper Fitzrovia, a fund research company which monitors TERs, says: 'Typically, large funds will have lower TERs than small funds, and funds investing in overseas markets will have higher TERs than UK funds.'

A fund with one of the highest TERs is Invesco Perpetual UK Recovery, which has an annual management charge of 1.5 per cent but a massive TER of 3.16. Invesco Perpetual says this is because it is a small fund, less than £1m in size, so the additional costs make up a relatively higher proportion of its overall expenses.

Less easy to explain is why some investment groups have higher TERs than others. Jupiter is one company at the top of the scale. Like Invesco Perpetual, it has a large and popular income fund with an identical annual management charge of 1.5 per cent, but the TER is 1.74 per cent whereas Invesco Perpetual charges only 1.58. Jupiter's European fund, similar in size to Artemis European with the same 1.5 per cent annual management charge, has a TER of 1.84, whereas Artemis charges 1.59.

Generally, it is multi-manager funds, which invest in a selection of other managers' funds, that tend to have the highest TERs as investors are paying two sets of management charges. The average TER on these funds is 2.48 per cent, compared with an average TER of 1.62 per cent for unit trusts and Oeics overall (excluding index trackers). Fidelity is the only provider of multi-manager funds that has promised to cap its TERs at 2 per cent.

'As disclosure of TERs increases, investors will hopefully pay more attention to this factor,' Moisson says. 'This is not to say they should only pick low-cost funds, but they should at least be aware of the potential "drag" on performance.'

Over time, high TERs can have a significant impact on performance. For example, a £10,000 investment in a fund growing by 7 per cent each year would reach £17,081 after 10 years if charges of 1.5 per cent were deducted. Annual charges of 2.5 per cent would reduce this to £15,545; at 3 per cent this would be reduced to £14,800.

But most investment advisers argue that buying funds with higher TERs can be worth it if the managers achieve better investment performance. Modray of Bestinvest says: 'Charges do matter, but they should not be an investor's first consideration. Find the type of fund you like and the managers that have achieved consistent performance, then compare TERs to see if you are getting value for money.'

To compare TERs on unit trusts and Oeics, visit the Investment Managers Association (IMA) website (www.investmentuk.org) which lists TERs in its 'find a fund' section. Investment trust TERs can be found on the Association of Investment Trust Companies (AITC) website (www.aitc.co.uk).

Guardian Unlimited © Guardian Newspapers Limited 2006