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Beneficiaries are suffering from the high cost of advice

18 May 09

Trustees are incurring unnecessary costs in fund management and other charges

by Alan Dick

I don’t know who coined the phrase “ignorance is bliss”, but I do know that where investments are concerned they were severely deluded. Trustees have a fiduciary responsibility to act in the best interest of the trust’s beneficiaries, yet few people are aware of the exorbitant, and often unnecessary, fees being paid for investment advice and execution.

Where a product, such as an offshore bond, is used for tax planning purposes, it will incur initial and annual charges in addition to the cost of any underlying investment funds. Some bonds pay advisers commission of up to 9% of the amount invested. The underlying investments also have a cost, both up front and ongoing. The initial “spread” to purchase units in a fund may be 5%. Therefore, a trust investing £100,000 could end up with only £86,450 invested on day one (£100,000 x 91% x 95%). The bond provider may play around with “allocation rates” or bonuses to disguise the level of initial charges, but ultimately the costs come out of the trustees’ pockets. Very few beneficiaries would see an immediate loss of 13.5% as a good investment strategy.

Unfortunately, the damage doesn’t stop there, as the investments will need to be managed over time. Once again, charges are often taken at multiple levels. The tax wrapper may charge, say 1% per annum with the underlying funds making an “annual management charge” of 1.5% per annum. You might legitimately expect the annual management charge (AMC) to be the cost of managing the assets. It is actually only the cost of deciding how to manage the assets. All of the fund’s internal trading costs are deducted from its assets in addition to any explicit management charge.

It is almost impossible to know the true cost of running an investment fund; in fact one survey by William Mercer found that over 50% of fund managers didn’t even measure how much of their clients’ money they spent on trading! However, a substantial body of academic research suggests the average cost of a round trip (i.e. selling one share in a portfolio and replacing it with another) could be as high as 1.8% (FSA Occasional Paper 6, “The cost of retail investing in the UK”, Kevin R James, February 2000). These invisible costs include broker fees and commissions, bid/offer spreads, market impact and stamp duty.

The average UK equity fund trades 72.1% of its portfolio each year (Lipper Fitzrovia, Benchmarking UK Portfolio Turnover, December 2007); this equates to a drag on client returns, through hidden costs, of around 1.3% pa (1.8% x 72.1%). These costs don’t show up anywhere, other than in the ultimate performance of the fund.

It doesn’t stop there either. The AMC is not even the full explicit cost of running the fund; other expenses such as audit fees, legal fees, marketing etc are charged to investors in addition to the stated management fee. The average “other expenses” for a UK equity fund are around 0.25% (Fitzrovia, above), but can be much higher. I recently met a couple who had a fund with an AMC of 1.5%, but a total expense ratio (TER) including other costs of 2.48%. This fund was held within an offshore bond, therefore adding a further layer of charges.

Some funds even have a performance fee of up to 30% of any profits over a set hurdle.

It is also important to realise that these are purely the fees for investment management and may or may not include investment and taxation advice to the trustees.

Contrast this with a simple institutional investment policy that would seem well suited to trustee investments. Where possible, the cost of asset custody and tax wrappers should have no initial fee. The underlying investment funds would also have no initial charges. Annual custody and tax wrapper costs could be as low as 0.2% per annum, and the TER of the underlying funds may be as low as 0.21% per annum. Any advice would be clearly charged separately either on an hourly rate, fixed fee or percentage of assets under management.

With equity markets around the world down by over 30% in the last 18 months, beneficiaries may not be very forgiving of high costs further eroding their assets. Recent market falls do, however, offer an opportunity for trustees to review and restructure existing portfolios when there is less likelihood of a capital gain or chargeable event.

Investment is a difficult enough subject for trustees to grapple with without the added leakage of valuable trust assets though unnecessary, but often avoidable, costs. While neither trustees nor their advisers can control the gyrations of investment markets, trustees can control the damage done to a trust’s assets through unnecessary costs and poor investment advice.

We often refer to the opaque charging structures of traditional investment markets as “legal theft”, in that the industry is stealing from its clients but no one goes to jail. Why? Because they told us they would be stealing from us – it just happened to be buried deep in the small print so we never saw it. Trustees should be careful they don’t become accessories to legal theft of their clients’ money.

Alan Dick is a member of EBIS (Evidence Based Investment Solutions –, and a member and founder of Forty Two Wealth Management (


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