Fund supermarket platforms are a popular way of building a portfolio of investments. However, under legislation being introduced in 2013, many investors who use investment platforms may be charged fees directly. The proposed changes, known as The Retail Distribution Review (RDR) will prevent platforms from paying referral fees and commission to advisers. The knock-on effect for DIY investors will be to pay up-front fees that were once hidden in annual management charges.
Investors are increasingly using platforms as a ‘one stop shop’ for their investments, but at the moment, many investors have no idea what they are paying for this service. The Investment Management Association (IMA), the industry body has published a document calling for greater transparency. They believe fund providers should offer “enhanced” disclosure of other fund costs such as transaction, entry, exit and performance fees. Under the proposed rules, platforms such as Hargreaves Lansdown, Vantage and Fidelity Funds Network may have to charge an upfront fee. There are an estimated 2.5 million people have platform accounts with about £85 billion invested, according to Barclays Wealth.
Not surprisingly, fund platforms prefer to bundle all associated charges together. Whilst it may appear convenient to allow platforms to handle investment related expenses, it provides an opportunity to hide kickbacks from product providers. The Whitehall Partnership Ltd has been a strong advocate of investment charge transparency for many years and we feel proposed legislation is long overdue. Investors deserve to know who is involved, how they are paid and what they do to earn their fee. The current system is clearly broken, which probably explains why some investors decide to go it alone by not involving financial advisors.
Let us be clear; fund managers, platforms and independent financial advisers have not instigated change, it has been thrust upon them. There are some wealth managers who know what is fair and already act in the true spirit of the legislation proposed. Nevertheless, they are a minority and consumer trust has been severely eroded by a financial system that rewards greed. It is therefore understandable why investors do it themselves; at least if mistakes are made, they have only themselves to blame.
Removing the middleman takes knowledge, commitment and time, but many investors prefer this hands-on approach. This method is best suited to investors who have spare cash and a sound investment philosophy. However, many DIY investors make the mistake of picking funds based on performance or anecdotal evidence, the same flawed approach followed by advisors. Modern portfolio theory has shown that long-term performance of the average fund is below stock market average returns. Unfortunately, despite this evidence, many investors are unaware of other low-cost alternatives because they are not available on most retail platforms. Some of these funds are disregarded by platforms if they refuse to get involved in financial back scratching, hence the need for greater transparency.
Unbundling investment charges goes some way to address the transparency issue, but big questions remain with fund management decisions. The financial market remains very competitive and usually leads fund managers to take unwarranted risk to appear top of the league table. These decisions often include short-term changes in asset allocation, by introducing risky assets such as derivatives, hedge funds or increasing equity exposure. Not all these decisions work out for fund managers, which create further haphazard trading techniques to recover losses, leading to inconsistent returns. This approach explains why most fund managers fail to produce consistent long-term performance and why investors ‘hop’ from one fund to another.
The key to a successful investing is low charges, exposure to pure asset class returns and systematic rebalancing to control risk. Ideally, the portfolio should exclude obscure and risky assets like hedge funds, derivatives, private equity or anything that claims to offer superior returns. Successful investing should not be regarded as an exciting adventure. Keep it simple and boring, because it works.