Investment fees: What am I paying for?

By Anna Fedorova

Whether you are buying a new car or a pair of shoes, it’s perfectly natural to shop around. You don’t want to buy a sub-par product just because it’s cheap, but equally you don’t want to spend an arm and a leg if you could have bought the same thing cheaper. It’s the same when it comes to investing. All investment products and services carry a price tag and it is important to know what you are paying for and how it compares to the wider market.

Whether you are buying a new car or a pair of shoes, it’s perfectly natural to shop around. You don’t want to buy a sub-par product just because it’s cheap, but equally you don’t want to spend an arm and a leg if you could have bought the same thing cheaper. It’s the same when it comes to investing. All investment products and services carry a price tag and it is important to know what you are paying for and how it compares to the wider market.

Investment fees incorporate a number of different things. There is the platform fee, which you pay to the platform provider through which you invest. There are fees you pay to the fund manager for running the fund. And there are also fees the fund managers pays for trading within the fund, which ultimately get passed onto the investor, more on these shortly.

Investment fees jargon buster

AMC: Stands for Annual Management Charge. It is the fee you pay to the fund provider for running the fund. This is calculated as a percentage of the total assets you have invested in the fund, usually on a daily basis.

OCF: Ongoing Charges Figure (also previously known as TER: Total Expense Ratio). This is thought of as a measure of the total annual cost of the fund to an investor. However, it’s important to be aware that there are some hidden costs that are still not included in this figure.

The OCF typically consists of the AMC plus other charges incurred for running the fund, such as custodian fees, trading fees, legal fees and other operational expenses. It does not include performance fees, trading costs such as broker commissions for buying and selling investments, stamp duty on share purchases, and bid-offer spreads (the difference between the buying and selling prices of an investment). While for some UK funds these extra costs are minimal (around an extra 5bps), in other cases these ‘hidden fees’ could more than double the total annual costs of your investment.

What is a fair fee?

The good news is that fund fees in the UK have been on a downward trajectory since the introduction of the Retail Distribution Review (RDR) in 2013. The main objective of this regulation was to stop paying commissions to advisers. For consumers, this meant more transparent and ultimately, lower fees. In fact, five years after the RDR was introduced, retail investors were paying on average 20% less for active funds and 28% less for passive funds according to research by Morningstar.

Active

You can find active funds with an OCFs anywhere between 0.30% and 1.25% (Source: Money Advice Service and Active Funds | Vanguard UK Professional). Fixed income funds are on average the cheapest, while multi-asset funds and specialist strategies tend to be at the more expensive end. OCFs for investment trusts can range from 0.36% to 1.8%, depending on the strategy and the manager (Source: Money Advice Service and Citywire) We will take a closer look at investment trusts in an upcoming post.

Passive

In general, passive fund fees tend to be lower than fees on active funds and you can find out why in this post. The average OCF for passive funds is usually between 0.25% to 0.85%, but some are a lot cheaper. Specialist strategies such as ESG or smart-beta ETFs are usually at the more expensive end of the spectrum, while some of the largest and most liquid strategies are the cheapest. So nowadays, you can pick up an ETF tracking the FTSE 100 index, for example, for less than 0.10% per annum - all in. If all you want is exposure to broad equity markets, that’s a no brainer.

Traditionally, active funds have been seen as an expensive way to invest, while passives were considered cheap. But the lines have become more blurred as fees compress on the active side and passive strategies proliferate and/or become more complex. The key thing to remember is that fees are important and you should know what you are paying, but the fee is just one component of your total return. Different funds have different goals and as long as you are clear on what your own goals are, you are well on your way to finding the right fund (with the right fee) for you.


Date of publication: 2nd September 2020

The information in this post is not financial advice, it is provided solely to help you make your own investment decisions. If you are unsure about whether an investment is appropriate for you, please seek professional financial advice. You can find more information here.

When you invest you should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future return.

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