Millions of small investors are losing out because of unacceptable charges on their stocks and shares Isas, investment funds and pensions, according to a new report from a body that advises Britain’s main financial watchdog.
A combination of poor disclosure of vital information, weak governance and multiple conflicts of interest mean competition in the £1tn retail investment market is “not working in the best interests of consumers”, concluded the Financial Services Consumer Panel.
The panel suggested fixing this by requiring fund management firms to quote a single, fully inclusive annual charge – though it said this remedy might “shock” some investors because this charge would be much higher than the currently quoted fees.
The consumer panel said the problem was that many of the costs of managing investments were simply not declared to customers, and were deducted without their knowledge, even though these charges could have a huge impact on returns. Some costs, such as trading spreads, may not even be known by the fund manager. So while a small investor might be told about the annual management charge (AMC) or the “total expense ratio”, these do not include the costs of trading shares or other securities.
“Many of the costs and charges are deducted directly from the fund and remain hidden,” said the panel, a statutory body that advises the Financial Conduct Authority. It said people were relying more and more on investments, especially in light of the recent pension reforms, and it was “completely unacceptable that consumers do not know what firms are charging them to manage money on their behalf, and cannot compare different offers”.
In a strongly worded conclusion, the report said the investment world was “a powerful industry in which misaligned incentives are systemic and which enjoys, largely unchallenged, the potential to exploit consumer behaviour, product structure complexity and the lack of cost transparency”.
Costs have a significant impact on the outcome of an investment. Last year the government said an individual who saved throughout their working life into a scheme with a 0.5% annual charge could lose about 13% of their pension pot at retirement as a result of charges. But a 1% annual charge could lop 24% off that pot. The panel said the problems it had identified were longstanding: in 2002 the government’s Sandler review of the retail investment market found that “the reporting of product charges is typically neither clear nor consistent”. In recent years, several leading fund managers have claimed investors are being overcharged and are losing out because of a lack of transparency. In September one of them, Neil Woodford criticised his industry for charging customers too much.
One of the studies commissioned by the panel, written by a team led by David Pitt-Watson, an executive fellow at London Business School and a former director at fund manager Hermes, said there was “a natural inclination for the industry to downplay the effect of charges, and even to be ‘economical with the truth’ in advising customers, since it is through charges that their income is earned”.
The panel said the problems needed fixing urgently, and it suggested that fund management firms could be required to quote a single and comprehensive annual charge that included estimates of “forward costs” such as transaction charges. All the other costs that are currently deducted directly from the fund would be borne by the firm, thereby enabling consumers to compare different firms’ charges, and acting as a “powerful incentive” to improve efficiency.
One panel member, Teresa Fritz, said that currently when it came to charges, “you only see the top of the iceberg... Consumers have the right to know the full costs of the funds they are investing into”.
She said the investment industry was likely to strongly resist the idea of a single charge because the headline figure they would have to declare would probably be a lot higher than the fees they currently quote. As a result, firms’ products “would, or could, look very costly all of a sudden to their investors”.
If consumers really knew the true cost of investment management, it might drive some to take their money out and put it into savings accounts and the like, she added.
