When investment fees become too high

In the last couple of weeks we have completed some audit reports on some IFA created portfolios, which showed the very worst aspects of how some IFAs have invested client’s money, with the encouragement of the industry at large. The three toxic ingredients are:

1. IFA wrap account fees – these allow IFAs to pass on to their clients consolidated investment reports across ISA, SIPP, Life Bond and Dealing accounts and have a central point for switching investments in the accounts. In short they make the IFAs life easy but at a cost to the client. Wrap fees vary from ‘bundled’ to ‘un bundled’ wraps in IFA speak, that means those with transparent un subsidised fees and those with hidden fees subsidised by fund manager trail commissions, but whichever way fees average 0.5% per year. Usually with some on boarding or exit fees and fixed product fees for each separate tax account as well. There is now an estimated £200bn of assets on IFA driven wrap platforms of one kind or another.
2. IFA trail fees, or asset based fees – this is now the Holy Grail for IFAs giving them recurring income in line with fund managers. However, most IFAs would be the first to admit they are not fund managers so are getting their clients to pay a third party for this as well. In many cases they still look to get their historic 3% up-front fee on every new penny invested on top of the trail fee. Typical trail fees start at 0.5% per year and go up to 1% a year for the more ambitious.
3. Expensive investment funds, products and third party portfolio managers - these come in a variety of guises from expensive traditional unit trusts with total expense ratios (TERs) approaching 2% through to third party discretionary managed portfolios and the worst offenders, in my opinion, structured products. On these latter products annualised fees can easily exceed 2% per year, all though you will be hard pressed to get anyone to tell you where and how much the fees are, very few people understand what’s under the bonnet.

Combining the three ingredients into a portfolio it’s easy to see how total fees can climb to 4% a year or more. An investor with say £250,000 in his IFA wrap account and saving £20,000 per year can be paying £10,000 a year in total costs to get invested. This is a long way away from the Government vision of stakeholder contracts with one fee less than 1% per year. The 1% level may be too extreme to deliver good service and good active management, but at four times this rate the chances of investors making any money over the long haul is significantly diminished.

It is entirely appropriate for investors who accumulate more than £100,000 in pensions and ISAs to look to consolidate these into a portfolio and get some active management, beyond a default managed fund or index tracker, however, total costs must be kept under control for this to be a step in the right direction with a likely improved outcome versus one where costs simply swamp any likely enhanced return.

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