Money: Fees that bite pockets

By PHILIP MACALISTER

To many investors the range of fees paid for professional money management services is like being stuck in a revolving door and paying money at every turn.

The correspondence to Mary Holm's Money Matters mailbag in the past three weeks shows it is a hot topic with investors.

It's also high on the list with regulators such as the Securities Commission, and with fund managers and advisers.

The sheer range of fees that are charged, or can be charged, by people and businesses in the professional money management game make it a particularly confusing area for investors.

At the fund-manager side of the deal there are entry fees, exit fees, management fees, trustee fees, switching fees, trail fees and management expense ratios. Financial planners and advisers can charge either a commission, or an hourly fee, or both.

What's more they are more than likely to charge a monitoring fee for providing regular portfolio reports to the investor.

So what are all the fees?

Entry fees

Most managed funds have some sort of entry fee. That is a fee subtracted from your initial investment.

While the concept of an entry fee is straightforward, the way it is promoted can be misleading or even confusing.

For instance, a managed fund may say in its brochure that the entry fee is 5 per cent. But that fee can vary from nothing through to the full 5 per cent, depending on how you buy the fund.

Generally, if you buy it directly from the manager the full fee is taken off your initial investment. You can get it for free, or at a discounted price, by buying the fund over the internet.

Alternatively, if you buy it through financial planners, the fee becomes discretionary. They can charge the full amount or nothing depending on their policy and what other charges they use.

Who gets it: The fund manager. However, it may be shared with the adviser.

How much: 0-6 per cent.

Advisory: You don't have to pay this fee and it is negotiable. Overall, entry fees are coming down or disappearing. WestpacTrust removed its entry fees recently.

Exit fees

Some investments charge an exit fee when you withdraw your money from a managed fund. In New Zealand, these are fairly rare but they can be found on products such as insurance bonds or superannuation funds.

Who gets it: The fund manager.

How much: 0-6 per cent.

Advisory: Exit fees are rare these days.

Trustee fees

Trustee fees are unique to managed funds, which by law, must employ a trustee to ensure the manager is complying with the fund's trust deed. Often trustees appears to do little for the investor. Their role is that of a watchdog, sorting things out when they go wrong.

Trustee fees in New Zealand are generally about 0.1 per cent of assets under management. If you go into a managed fund there is no way of avoiding trustee fees.

Who gets it: The trustee.

How much: Around 0.1%.

Advisory: Trustee fees in unit trusts are unavoidable.

Management Fees

Management fees are the amount of money paid to the manager for professionally looking after your money.

There is a wide range fees in this area. Cash and fixed-interest trusts have the lowest fees as they are relatively simple to manage, while actively managed share funds are the most expensive because they require far more work, and often management is subcontracted to overseas firms.

Management fees are also the area where fees change the most because of competitive pressures and economies of scale.

Recently, Bank of New Zealand lowered the fees on its Future Lifestyle fund from 1.5 per cent to 1 per cent because the funds are now focused on assets at the cash and fixed-interest end of the spectrum.

Who gets it: The fund manager.

How much: 0-2%.

Advisory: Compare management fees in similar types of funds and make sure your manager isn't the highest paid. Also, make sure the fee level is appropriate for the type of assets managed.

Trail Fees

Trail fees are commissions paid from the fund manager to the adviser annually as a way of rewarding them for their continued support.

Though they are almost invisible to the investor, they are a vital income source to an adviser's business.

Trails have two main impacts on an investment. First, while the fee is paid from the manager to the adviser, the money is coming from your investment. Second, it can be argued that the level of the fee may influence the products recommended by an adviser.

In New Zealand, the standard trail paid to an adviser is about 0.25 per cent; however, the range is large. Some investments don't pay trails; others pay an adviser 1.0 per cent.

It's rare for advisers to disclose the actual amount they receive in trails. But they have to make this information available if you ask for it.

Who gets it: The adviser.

How much: 0-1%.

Advisory: Ask your adviser to disclose how much money he/she gets paid in trail fees. Some managers will stop paying trail fees to advisers if you ask.

Management Expense Ratios (MER)

These are not so much fees, but a measure of what level of cost a manager takes for running the business. MERs show whether the manager is efficient or is creaming the unit holders. The biggest problem in New Zealand is that there is poor disclosure of MERs and there is some dispute over the industry standard.

Advisory: These are useful for comparing whether you have a cheap or expensive manager. However, the information can be hard to get hold of, and MERs are not always directly comparable.

Securities Commission chief executive John Farrell says the issue of fund management fees and their disclosure is "prime fodder" for the regulators.

The commission is involved in two "scraps" with fund managers over fees.

Fees are one of the first things the commission looks at when reviewing investments.

It often finds the level of disclosure is "awful" and action includes getting the promoter to change its documentation, or even making the manager reimburse investors who have put money into a fund with poor disclosure.

Though the issue is "prime fodder" for the commission and there are serious concerns, there is no simple answer.

Mr Farrell's preference is for the industry to set standards for disclosure.

However, little has been done on this to date.

One area where the industry, through the Investment Savings and Insurance Association, has tried to set standards is with a rule for MER disclosure.

But this has been criticised for its flexibility over what can be included or excluded in the calculation.

Diversified Investment Strategies director Norman Stacey says that calling it a standard is a loose use of the word. The main problem is that managers can choose what expenses to include in the calculation, so can massage their expense ratios.

ISI chief executive Vance Arkinstall acknowledges the standard has had its problems, and says it is under review.

"Quite frankly, I think we will be making changes," he says.

The Securities Commission is also concerned about the method financial planners and investment advisers charge fees.

In theory, they have to fully disclose fees under the Investment Advisers Disclosure Act.

Under this, there is a relatively small amount of information which has to be disclosed, then a further amount of information which has to be disclosed only if the customer specifically asks for it.

Mr Farrell says this two-tiered approach does not work as most people have no idea they can ask for this information.

He says the issue is high on the commission's work list for the year.

Further criticism has been levelled at advisers for the way they charge fees in master trusts and wrap accounts.

These are tools used by advisers to consolidate each client's investment information into one statement.

They were established primarily to allow advisers to spend more time with their customers, as opposed to being stuck in the office doing paperwork.

But Consumers Institute research writer David Hindley says some of the charging structures are so complex, and the information so obscure, that it is impossible for the average small investor to do the sort of comparative shopping he/she might do with a more simple investment.

Mr Hindley says there is an enormous range in fees. He is aware of one master trust with fees of around half a per cent a year, and others pitched at 2-2.5 per cent.

"The higher figures can have a devastating impact on returns. Together with tax, a high fee can literally chop a gross return in half, or worse."

The importance of fees on an investment portfolio cannot be underestimated. In fact, they are one of the most important aspects of a successful investment strategy, alongside the actual asset allocation.

Investors need to remember that no matter what the fee is, or who charges it, they are the ones paying it.

The best advice is: Don't take for granted the level of fees you think you are paying.

Dig into your investments and have a good look at who is getting what - you might find some unpleasant surprises.

But remember that if you choose to use the skills of professional money managers you will have to pay them.

It's not so much the fee that matters, but whether you feel you are getting value for your money.

* Philip Macalister is the editor of online money management magazine Good Returns. Good Returns provides news on managed funds, mortgages, insurance, superannuation and financial planning.