Cost and transparency
Exploring an issue brought to the fore by Mifid II.
Mickey Morrissey: Transparency has always been an issue, but it’s really come to the fore with Mifid II. And it’s quite a challenge. We’ve seen the post-ante and ex-ante numbers coming through, and some of them look awful. Will clients look at the cost projections over the next five years and think, I’ll just buy a new car instead?
Tony Wassell: Actually, I like Mifid II. Is that bizarre for an advisory firm? I like that we can sit down with the client and say, ‘This is the Mifid II version of your fees, bearing in mind that the ongoing charges figure is already sold within the funds.’ As long as you explain that this doesn’t change anything, it’s nothing to be feared.
Mickey Morrissey: My fear is that if it’s not explained it will force people down a different route, notably passive investing.
Alex Morris: RDR (retail distribution review) was great, because it cleared everything up and made everything transparent. What I find interesting with clients is that when I came into the industry 20 years ago, commission was prevalent. You’d offer the client fees and they’d decline them, because they’d rather pay for the service where, typically on a pension or an ISA, you’d have a 1.5% annual management charge and a third of that would go to the adviser. Clients never questioned it, because that’s the way it always was. After RDR, you’re paying fees and they’re broken down by advice given, platform charges etc. The cost is actually half what it used to be, but now the client questions everything.
Dave Field: The thing about RDR in the UK is that there was a transition. We might look at the legislation and think, those labels don’t make sense, but that’s the legislation and that’s what you’re going to have to run past the client. Once everyone understands what all this means, it makes sense and it’s all relatively straightforward. In the UK, you’ll probably have six months of people getting familiar with the new formats and information.
Mickey Morrissey: RDR made openended funds cheaper in the UK. Before that, investment companies were often the less expensive option, but all that now seems to have changed, with openended funds charging around 0.75% and investment companies still sitting at 1.5%. But, and Nick I’d like you to touch on this, investment companies have found a way to level the playing field with a system that doesn’t exist in the open-ended space. Once an investment company reaches a certain level, say £500 million, the price drops, and when it gets even higher the price drops again — it works on a gradient.
Nick Britton: Although the changes to commission following RDR levelled the playing field somewhat for investment companies, a less advantageous consequence was that open-ended funds became noticeably cheaper. So, as a result of RDR, in the past five years, about 40% of the industry has changed its fees. And those were typically reductions in the base fee and the tiered fees. Performance fees, however, are driven by the board, because the thing about investment companies is that you have an independent board that actually negotiates the fees on behalf of you the shareholder. That means they can react quickly to pressures in the market, which is why fees have been coming down.
The problem remains that we still don’t really have a level playing field. Investment companies aren’t as available on platforms. That’s frustrating, because investment companies are part of the solution for bringing better value to the market.
Alex Morris: It feels like we’re only talking about cost. When we look at a fund, we look at how long it’s existed, how long the manager’s been there, what was performance like at the time of Lehmans’ collapse. Cost is the final consideration. And that’s because very few clients put cost at the top of the list of criteria. And how they approach cost when they do consider it differs from client to client. So, when we go to the client with six to eight funds that our analysis has identified as suitable, we say, ‘Do you have a cut-off point on cost — is anything above 1.85% or 2% TER (total expense ratio) too much?’ We’ll ask, ‘Do you want to have less in the more expensive funds? Is diversity so important to you that you have an equal percentage in all of them?’ It’s interesting, I’ve never had the same answer to the same question.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.