Investments shrivel, but City fees are immutable

Investments shrivel, but City fees are immutable

Fund managers are feeling the heat. Accusations that they are fleecing investors with hidden charges have come at an awkward time for an industry that has lurked in the shadows of the financial crisis.

City minister Lord Myners has unsettled the industry's top brass with calls for investors to question the weak link between pay and performance. A former fund manager himself, Myners is frustrated at the resistance to reform.

This month Alan Miller, formerly of fund manager New Star, turned the screw with a forensic dissection of hidden charges. On his list were the up-front charges, dealing costs, trading commissions, stamp duty, research, marketing, compliance and accounting costs that are lumped together and taken from an investor's fund. The manager's fee is separate and immutable.

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He said the industry's standard measure of operating costs, the total expense ratio (TER), should be replaced with a calculation that includes all the costs of running a fund. An advertised annual running cost of 1.5% quickly becomes nearer 3%.

Today the Investment Management Association hit back. In a three page document it argued extra costs were either unquantifiable or insignificant. Over five and 10 years investors were still making gains with little impact from costs. Net gains were the all-important measure.

Miller's response was incredulity. Why was the industry unwilling to make charges transparent? Dealing costs are significant, along with the stamp duty that must be paid on each transaction, as managers buy and sell shares to maximise returns. Bid/offer spreads can be colossal. Up-front fees can be 5%.

The IMA had focused on tracker funds, where costs are traditionally low and getter lower. Anyone defending the industry would naturally spotlight annual charges that can be 0.3%.

However, the same issue of transparency applies. In the active fund management industry the figures are opaque and higher.

In an era when hedge funds make sure volatility is the name of the game it was always going to be harder to make money. The IMA's figures bear this out. Over 10 years, including up-front fees and all the hidden charges, two-thirds of active fund managers underperformed the All-Share Index.

That's a magnificent failure given all the expense and effort put in. Lifting the veil on costs should be a matter of urgency.

Retired hurtPension funds ought to be first in the queue for more information on costs. Figures from one advisory firm show that the collapse in bond yields, increases in life expectancy and the prospect of even modest inflation have sent deficits in final salary occupational funds soaring. A few months ago the total deficit figure for the UK's 7,400 funds stood at around £820bn. Now it could be more like £1.2tn.

When the figures are this big, it might seem petty to devote hours to tackling fund management costs. But the investment industries extract billions every month from investor's pockets with the promise of market beating gains.

Last week JP Morgan declared £5.1bn in profits over the first nine months of the year. Goldman Sachs reported an almost 300% rise in quarterly profits to $3.2bn. Royal Bank of Scotland is expected to report a loss for the year offset by huge investment banking profits.

So what is stopping pension fundsfrom supporting sweeping reform of the City, when they are the biggest losers from the scandal of the financial crisis? Hardly a day goes by without a pension fund announcing it is putting more money into private equity or hedge funds, where fees are many times higher. They gleefully announce how the deficits in their funds will close once the Mayfair set are allowed to work their clever schemes, speculating on oil, wheat and any other asset vulnerable to an excess of short-term cash pouring in.

Could it be that the search for yield is back, as a report in this section today suggests? Conversations in the City show that calls for reform come second to the voracious hunt for market-beating gains that drove the dotcom bubble – and when that had popped, the lending bubble of 2003 to 2007.

Investors are wounded by the financial crisis. They have lost billions and are angry. But, with a few exceptions, they want fund managers to juggle conversations about reform while actively seeking out higher returns. The argument that a search for yield might conflict with much-needed reform is lost on a community trying to get its money back.

The implications for wider society are serious. Investors are less a class than a generation. They are the baby boomers who want their golden retirement. If they reach their promised land, everyone else will be the loser.

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