I received many responses to my column last week on the way we pay for our money to be managed.
Traditionally, all fund managers charge us a percentage of the value of assets under management on an annual basis.
My view on this is twofold. First, it might be better – more transparent and hence more honest – to charge flat fees rather than percentage-based fees. And, second, even if one were to accept that a percentage-fee system is the best one, the current level of charges is far too high.
There was agreement on the second point – oddly, I haven’t had a single email from a fund manager justifying the level of fees. Instead, most emails claimed that the problem is not the system but the way the industry uses it.
A pensions lawyer emailed to say that he finds some of the charging structures he is asked to review for the management of occupational schemes “breathtaking” – given that the “direct and real impact of this issue on the pockets of ordinary taxpayers dwarfs anything they might suffer as a result of MPs buying the odd illicit duck house”.
On the first point, there is less consensus. The primary objection to flat fees – which comes from the industry – is that percentage-based fees align the interests of investor and manager: when the manager makes money for the fund, the fund gets bigger and hence his take rises.
I accept that this is the case, but I don’t see how it invalidates the argument for flat fees. Surely here, too, success brings its own reward. As I said last week: “Do a good job and you’ll get more clients which will mean more fees; do a really good job and the market might think you justified in raising your fees.”
The second objection is that flat fees just can’t work for a business. I have to say that, regardless of the explanations, I still don’t really understand why. Let’s take a small unit trust with £100m under management. With a 1.5% annual management fee, it is bringing in £1.5m a year. Nice work…
But what should it really cost to run? Say £75,000 to pay the manager, £40,000 to pay his assistant, another £20,000-odd for administrative support, £100,000 for rent, travel and overheads (I’m being generous here) and maybe another £60,000 for advertising. That’s £285,000.
Then let’s give the managers a really nice profit of another £150,000-odd. That takes us up to £450,000. You only need 1,800 investors to pay £250, or 3,600 to pay £125 a year each, to make that work.
Fund managers will say that’s not enough – that they need the extra million to pay “distribution costs” – i.e. trail commissions to IFAs. I’d say they shouldn’t pay them anyway. They’ll say that £75,000 isn’t enough to hire a good fund manager. I’d say it is certainly enough to hire an average fund manager (and most are average). And they’ll say that it discriminates against small investors; that it will be too hard to deal with investors who redeem after less than a year; that it will encourage them to be passive rather than bearing the cost of active management.
But I’d say that managers who think they can outperform the market over the long term should surely also think themselves capable of working out solutions to such petty problems.
Finally, there were a few readers who thought the fees were by the by. Much more important, said one, was to find a way to ensure that fund managers “outperform or at least match” the market in a bull market and protect all profits made during subsequent bear markets.
If that were possible, I would absolutely agree. If I could be sure I’d never lose money, I’d pay any fee asked by anyone. But history tells us it is not.
So what is the conclusion? It may be true that no one will be able to make a flat-fee system work, or perhaps that no one will be willing to try. But if that is so, I’d argue that the next best step would be to regulate for absolute transparency.
Instead of just being allowed to remove their fees from the pot automatically so that the investor never really sees, feels or understands them, managers should have to send investors a physical bill asking for separate payment at the end of each quarter (Dear Mr Investor, Please find enclosed our bill for £250 for the management of your £50,000 over the last three months. Yours, Big Fund Management).
That should focus the mind of the average investor and inject some price competition into the market. One reader accused me of writing about this because I want to “stir up a hornets’ nest.” He’s right. And once it is well stirred, I hope some good will come of the irritation it brings.
• This article was first published in the Financial Times