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Five things you need to know about the City watchdog’s fund management probe

FCA report finds investment industry lacking in competition and transparency

The fund management industry lacks transparency and competition – and doesn’t always act in the best interests of investors, City watchdog the Financial Conduct Authority has found.

The regulator’s long-awaited 113-page report has wide-ranging ramifications for pension and stocks and shares Isa investors.

Here are five things investors need to know.

1. You don’t always get what you pay for

You might be tempted to think that if you pay a premium price, you’ll get a premium product. This is normal in other industries – airline tickets, for example. But the idea doesn’t hold up when it comes to investment funds. The FCA found that fund managers who charged a higher fee for their funds did not consistently deliver better performance.

In fact, it’s worse than that – while it didn’t find a correlation between higher fees and better performance, the FCA did find some correlation between higher fees and worse performance. Remember, any fee taken every year as a percentage of the amount you’ve invested is a direct drag on your returns. If your investments made 5% in a year, but you paid a total of 2% in fees, then you would only effectively have made 3%.

And fees are taken out regardless of performance, so if you’d only made 1% on your investments that year, the 2% fee would mean you were actually losing money.

2. Fund managers are happy to take a slice of your money, but very reluctant to give any back

One key problem identified by the FCA is that fund managers don’t pass savings made through economies of scale back to you, the investor. A fund that has £100 million under management might take, say £750,000 a year in fees (a fee of 0.75%).

A £1 billion fund would probably take the same 0.75% fee, except earn ten times as much from it – £7,500,000. It doesn’t cost 10 times as much to run a fund that is 10 times bigger – but those savings aren’t being passed back to you.

3. Investment charges aren’t well understood

The FCA uncovered a worrying statistic – almost half of the people it surveyed said they thought they weren’t paying charges for their funds, or that they weren’t sure.

The FCA’s proposed solution is an all-in-one ongoing fund charge that investors can have confidence in. Crucially, this would include an estimate of transaction costs – those a fund incurs when it buys and sells assets. At the moment, these costs aren’t included, which means the true cost of investing is often significantly higher than fund managers claim.

4. Absolute return funds don’t deliver absolute return

Absolute return funds are a specialised type of investment product that aims to deliver predictable returns from one year to the next, regardless of market movements. But the FCA found that many of these funds are failing in their mission – of the 74 absolute return funds, 30 reported negative performance over at least 12 of 24 rolling monthly periods. The FCA warned that ‘these numbers suggest that customers can face a relatively high likelihood of negative performance’.

5. Fund managers aren’t under pressure to cut charges

Overall, the picture painted by the FCA is one of complacency – fund managers simply aren’t under pressured to drop prices. Fund managers are happy to continue charging 0.75% regardless of how well they do, or how big their funds get.

One thing is certain – the fund managers are doing very well indeed, with profit margins averaging 36%. This suggests there is plenty of room to pass savings back to investors, but if investors don’t hold them to account or vote with their feet, they have no reason to change.

Which? Money Editor, Harry Rose, said:

‘The asset management industry has, for too long, offered investors poor value for money, misleading information and poor performance. Anyone investing in Isas or pensions needs to know that they can trust the information available so they can make informed, long-term decisions.’

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