FOOL'S EYE VIEW
Cheap Funds Hit The Spot

By Stuart Watson (TMFTiger)
October 16, 2001

Great Titchfield Street, London -- One of the more subdued announcements of last week was the launch of the FSA's comparitive tables. These are designed to provide an independent source of information to help us choose financial products. So do they do the business? Or is this just another strain of the plague called information overload?

At this point, the tables only cover unit trust ISAs, and specifically, the UK Growth sector. This means they only cover about 100 funds out of the 2,000 or so unit trusts available. However, this sector is by far the largest, accounting for around 30% by value of money invested. Further tables are due to published in the coming weeks that will cover pensions, mortgages, investment bonds, savings and mortgage endowments.

Keeping It Simple

I found the tables pretty simple to operate, with helpful information available if you need more details. You can download the information for a more detailed perusal and general fiddling at your own leisure. The main feature of the tables shows how much you will pay in charges, based upon how long you invest for (10 or 25 years) and how much you put in per month or in a lump sum. The tables also include where you can get the fund, the cost of early redemption and minimum investment amounts.

No data on the past performance was included, which is not surprising given recent statements made by the FSA. This omission has provoked some frighteningly inept comments from the fund management industry. Their basic premise was that past performance was a useful indicator for selecting a fund and that cost was not. However, virtually every piece of research ever carried out has suggested that the opposite is true. Lots of people may use past performance when picking an investment, but that doesn't mean that they are correct to do so.

The presentation of the charges in the FSA tables may confuse some people. All you are told is how much in actual pounds you can expect to pay should the fund grow at a certain percentage each year (7% in fact). Say you put in £250 a month for 10 years. You'll find the total charges vary from around £1,000 to as much as £7,000. On the basis of these assumptions, the average tracker fund in the list costs around half as much as the average non-tracker. From the data provided, it's hard to work out if a fund actually is cheap, although it's easy to see if it is cheaper than another fund.

Most of us are more used to seeing the charges presented in percentage form. Ideally, we'd like to see Total Expense Ratios, which include all the charges that are made. It's unclear if the comparative tables include nasty little extras like trustees' fees that are usually hidden away in the small print, or whether they are primarily based upon the annual management charge.

Not 'Best Buys'

The FSA has gone to great lengths to point out that you shouldn't base an investment decision on the information they show in the tables. However, cost is definitely one of the considerations (in our view, almost certainly the most important one) you need to bear in mind. As the press release accompanying the launch says:

Understandably, tracker funds tend towards the lower end of charges where as actively managed tend to be more expensive. This does not mean that the more expensive funds are not worth buying but that they will typically have to outperform the cheapest fund by more than 2% compound over 10 years simply to eliminate the effect of the higher charges.

Although 2% may not sound like a lot, it's a hefty handicap that few funds will be able to overcome. Some will of course. The only trouble is that you can't tell which funds will do so until after the event. And the charges remain the same, whatever the outcome. Perhaps it's time that fund managers were paid for performance. Many of us are also 'encouraged' to change funds on a frequent basis, incurring yet more charges.

The Verdict

So what's the overall verdict on these tables? We think this is useful addition to the consumer's armoury. It's a good first step on the road to greater transparency but let's hope the pace is kept up. You can almost guarantee that whenever the financial services industry starts jumping up and down, it's not because they are concerned about offering you decent value for money, but rather they perceive their profits are under threat.

It's going to be interesting to see some of the other tables and the level of charges that they reveal. We suspect that the numbers for investment bonds and endowments could be particularly eye-watering. If people start to realise just how much leakage from their wealth some investment products will inflict upon them, then these tables will be well worth the effort.

More: FSA Comparative Tables | TMF ISA Centre