06th April 2023
We work in an industry that loves an analogy. I suppose it’s because some of the concepts around investing are not intuitive and we are forever (rightly) trying to make ourselves more accessible to our underlying customers who will be less financially literate than us. But in using analogies we risk making the situation worse (i.e. confusing not elucidating). Analogies are especially plentiful around the issue of costs, charges and fees for investment portfolios (be they funds, models or bespoke). By the far the most often used analogies are supermarkets and cars. Funds, like ours and many others, with optically higher “costs” (as represented by the OCF – Ongoing charge Figure) are often compared to Marks and Spencer (other higher-end supermarkets are available) or Ferraris (other cars are available etc etc). Lower cost funds are compared to Aldi or Lidl or Skodas. But these analogies are terrible!
Funds are not consumer goods. The investor (or purchaser of units) doesn’t pay all of the costs up front, as you would a basket of goods from a supermarket, or a car. With a fund, the costs only become apparent with the fullness of time and in any case are only relevant in the context of performance. Funds all charge customers in the same way – via the annual management charge, which is an ad valorem (percentage) fee that is charged on a daily basis. The “product” is the fund itself, and in so far as it is a collection of investments designed to produce a return, is homogeneous. You cannot have different kinds of 5% net performance (let’s ignore volatility for today). On day 1 the investor puts in £1,000 and receives £1,000 of units in the fund – regardless of what kind of fund it is. At the end of the investment period, the investor sells her / his units and receives a sum of money back. It’s the same type of currency received at the end (even if the quantum will differ). There is no initial charge (or shouldn’t be for the kind of funds I am talking about). The “cost” of this activity are not borne up front. With a car or a basket of goods, the cost is paid for at the outset and the benefits (driving enjoyment and engine performance or taste / quality of food) is enjoyed subsequently.
So the first thing we have to do is understand that with all funds, and investment portfolios, the true cost is actually not known at the point of purchase. This is where the concept of “opportunity cost” comes in – this is the idea of “what you could have won”. In the world of investment, no one wants to pay 1% for 5% performance when they could pay 2% for 10% performance. The former has a much higher opportunity cost. And here is where these analogies (sort of) work:
A basket of goods from M&S is different to a basket of goods from Aldi and the two should not be compared using ticket prices alone (we need to know about brand, quality, ingredients, taste, freshness, shopping experience etc etc). A fund of funds is different to a directly invested passive multi-asset offering and these should not be compared using the current definition of OCFs alone. The current regime, which forces the OCF to include “synthetic” costs – that is the underlying costs of the investments that make up a portfolio – forces a frankly useless comparison. There is no room for WHY the OCFs are so different. It’s like a car novice walking into a car garage and being shown a Ferrari next to a Skoda and not being told anything about either car except its price and being asked which one they’d like.
The current OCF regime puts all but the lowest cost funds at an extreme disadvantage. If this way of representing costs is fair, why are funds of funds labelled “expensive.” If this is true, why does no one ask why people like us even bother? We invest like this because we believe the opportunity cost of not doing so is high. Or in plain English, because we believe performance after charges will be better (enabling us to access experts in niche areas of markets or assets we cannot access directly for example). Goodness knows, we don’t do this for our health, our bank balance or for purely commercial reasons (indeed, these days it’s virtually commercial suicide!). What the investor gets is after charge performance – which is a concept that’s the same regardless of the nature of the fund. That’s the product we’re selling: performance. The way we deliver it is different to a lower cost fund, but ultimately we’re all “selling” the same thing. And that is why there really is no good analogy and why we as an industry must do two things:
- Educate – increase financial literacy so we do not have to rely on a regime that boils concepts like cost into misleading one-number regimes like the OCF
- Create a cost disclosure regime that does what everyone wants: discloses all costs in appropriate manner and aids comparison
This is why we have been campaigning for the OCF to include only those costs that are unavoidable and associated with the fund manager (namely AMC, ACD and admin costs). Disclose the synthetic costs separately. This enables the consumer to see exactly what the “manufacturer” (to use Consumer Duty language) is earning from the “product”, and thereafter what the costs associated with the method of producing that product are (the synthetic costs). In doing so, the consumer can immediately decipher the nature of the fund (whether it is directly invested or not) and adjust their decision-making accordingly. Ultimately, they might even come to the most sensible (in our view) conclusions of all:
-none of us have solved investment (there is no wrong or right way)
-everyone does investment differently
-it’s impossible to know what performance is going to be before the event
-it’s best to blend different types of funds and investment processes
Ben Conway – Head of Fund Management
For professional advisers only. This article is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. FPC950.