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European Union acts on hidden fund fees

All serious investors know that they should keep costs low and we were pleased to see an Investors Chronicle reader describe this week how he aims to keep his portfolio costs below 1 per cent. There are good reasons for this.

While compound interest is the friend of the investor, it is also the friend of the fund manager, platform or adviser who takes fees from your portfolio.

The government brought this to investors' attention in October 2013, with its announcement that it wanted to cap the annual management fees that pension funds charge to look after our money at 0.75 per cent. The Department for Work and Pensions said someone who saves £100 a month over a typical working lifetime of 46 years could lose almost £170,000 from their pension pot with a 1 per cent charge and over £230,000 with a 1.5 per cent charge.

Meanwhile, new research from low cost passive fund provider Vanguard Asset Management shows that a long-term investor who subscribes the full £11,520 to a stocks and shares Isa this year could be overpaying nearly £10,000 in high fees. If you can knock 1 per cent off your annual charges you could end up with an Isa that is more than a third bigger after 30 years (see table).

Effect of fund fees on full 2013-14 Stocks and Shares Isa contribution

Assumed return: 5%*

Initial contribution: £11,520

YearsOngoing charge 0.50%Ongoing charge 1.00%Ongoing charge 1.50%% difference in size of portfolio
5£14,066£13,720£13,3825.11%
10£17,174£16,339£15,54510.40%
15£20,970£19,459£18,05716.10%
20£25,604£23,175£20,97522.10%
25£31,263£27,600£24,36528.30%
30£38,171£32,870£28,30334.90%

Source: Vanguard Asset Management Limited 2014.

*Assumes a 5% nominal annual return and 0.5% inflation, i.e. a 4.5% real annual return.

However, the costs of actively managed funds are actually higher than most investors realise. Our reader can only target a reduction in the costs that the managers disclose, which include the annual management charge that goes to the fund manager, plus administration costs. The underlying trading costs and a raft of other charges remain hidden. But not for long.

The European Union has announced that its Markets in Financial Instruments Directive II (MiFID) will force financial firms to report the total cost of investments to consumers. This will include the adviser costs, product costs, third party costs, transaction costs and all the other previously hidden costs.

The cost will need to be expressed as a single number as well as be disclosed in an "understandable format". Investors will also be able to request an itemised breakdown of all the costs. The changes will need to be implemented by 2016.

On the same theme, the government has tabled an amendment to the Pensions Bill to require pension providers to disclose all transaction costs in defined contribution workplace pensions. Minister for Pensions Steve Webb said: "For the first time, we are shining a light into the murky corners of the pensions industry to make sure savers know what is happening to their money. A lack of transparency around the true costs of trading can prevent schemes from securing value for money for their members."

Gina Miller, founder of the True and Fair Campaign, says: "The writing is finally on the wall for rip-off pension and investment costs and fees. However, it is staggering that it takes government action to make the pensions industry disclose these costs to pension savers."

Any action on pension fees could take some time. The pensions minister Steve Webb in January said that he would delay the new 0.75 per cent limit on autoenrolment charges until April 2015 to give employers time to adjust to the changes.

So, in the meantime, if you have a pension scheme, raise the issue of fees by challenging your pension trustees. Ask them what you are paying for the management of your pension, and whether they have questioned the fund managers about trading costs.

Investors concerned about minimising fees should look for fund managers who aim to minimise trading costs. These include Nick Train of Finsbury Growth and Income (FGT) and Terry Smith of Fundsmith Equity (GB00B4LPDJ14). Also take a look at Scottish Mortgage (SMT), Templeton Emerging Markets (TEM) and Temple Bar (TMPL) investment trusts, which target average holding periods of five years.