The FCA’s spotlight on fees engendered a long over-due focus on charges for all in financial services who reside along the multiple links of a customer’s value chain.  In the world of funds, industry-wide launches of “clean” share classes from 2013 onwards was part of a huge “unbundling” exercise, which promoted greater understanding about the cost of purchasing and holding investment products.

The debate about costs and “value for money” is far from over and this remains a complex area, filled with subjectivity and swayed by the vagaries of dynamic investment markets.  Even if you fathom the total cost of product ownership, how do you determine whether it represents value for money?  The cheapest is not necessarily the “best”, and, more to the point, may not be the most suitable for a customer’s needs.

A low return world?

Indeed, we should expect cost pressures to intensify if lower investment returns add fuel to the regulatory imperatives.  After the “Big Bang” in 1986, the finance industry expanded rapidly and set its price points during an era of higher real growth (thanks, in part, to higher inflation), as well as looser regulation and less competition.  Today, we are operating in a mature industry in a lower return world.  Monetary policy is on the floor and central banks around the world are firmly in the dovish camp.  Who would have imagined that 2.5% might be the peak for US rates?

To explore what this might mean for investment portfolios, let’s review a few facts:

• At the time of writing, the UK base rate stands at 0.75% and the 10-year gilt yield is 1.18%.  It is not a stretch to suggest that the total return potential from fixed income is, at best, muted.
• GDP growth is modest (around 1.4% in the UK), as is inflation (around 1.9%).  The brutal transparency of the internet means that pricing power for companies is limited.  Capital is cheap and easy to access and hence, barriers to entry are low and competition is fierce.  Therefore, we should expect company profitability (in aggregate) to be commensurately low (continuing the trend of recent years). This adds up to modest returns from equities.

With this in mind, what level of total return could we expect from a simple, balanced portfolio of 60% UK equities and 40% bonds?  Let’s assume a yield of 3% from a diversified bond portfolio and a dividend yield of 4% from a UK equity portfolio; let’s also bake in some modest earnings growth from equities.  Such a scenario would suggest a total return in the region of 5% pa, gross of fees.

In the context of paltry savings account rates and low inflation, a 5% return is not to be sniffed at.  The problem comes when you translate the gross return to a net return.  For some retail investors, around half of that available return could be eviscerated by the costs of being invested, engendering tough conversations with customers who are also now armed with enhanced costs and charges disclosures.

The price versus value-for-money question

In the multi-asset solutions space, the issue of price alone can be handled by using packages based upon passive vehicles, such as those offered by the likes of BlackRock, LGIM and Vanguard.  These are simple and effective products that, for many investors, are adequate for their needs and provide highly diversified exposures to a blend of markets and assets.

Passive investing is not for everybody, of course.  An investor may be seeking an alternative kind of outcome, one that is more defensive in nature perhaps, or one that provides a sustainable/growing income stream.  Step up the “Daddies” of the multi-asset world…good, old-fashioned managed funds.  Some of the cautious and balanced funds of yesteryear have survived the numerous market cycles and investing trends that have come and gone.  Their beauty is often in their simplicity; furthermore, they often have a tried and tested approach, are run by trusted managers and are supported by robust internal resources.  The OCFs for the clean share classes of such funds typically reside in the 0.70% to 0.90% range, arguably a fair price, but quite a hurdle nonetheless in the context of low-returning markets.

This takes us on to the multi-managers, where price has been at the heart of the conversation for years, given their more challenging cost structures.  By necessity, they have become more adept at explaining the value that they offer, over and beyond success in net return terms alone.  Some multi-manager teams have been operating together for many years and can boast experience and stability, offering a “safe pair of hands” to advisers looking for an answer to the problem of selecting and blending funds from across the market to achieve a particular outcome.  With their dedication to the task in hand, they are also better placed to identify specialist funds that might otherwise be difficult to access and/or complicated to analyse.  Asset allocation may be another skill that is offered.  Cognisant of the practical needs of their intermediary clients, some have put great effort into high-quality reporting that is tailored to the challenges of investor communication.  In other words, they understand the value of offering a full-scale investment service that is more than just a monthly fact sheet.   Advisers will have their own opinion about the costs versus value of multi-manager offerings, but it is probably fair to say that pricing is an ever-present barrier to overcome, particularly given an array of competing products and services.

Increasingly, discretionary fund managers have stepped across into ground that used to be occupied by multi-managers.  In the same way, advisers will have their own view of the value that these services represent in the context of the fees charged, but again, the concept of a holistic investment service is one way in which DFMs can set themselves apart from packaged products.

Acutely aware of the cost and regulatory backdrop, as well as the prospects for investment returns, intermediaries are playing their part in looking for ways to reduce the costs that are reaped from their customers’ portfolio by various service providers.  This is seeing some advisers turning (or returning) to in-sourced investment propositions as a way of reducing costs and retaining more of the investment control and the economics.  Larger firms are taking this further by establishing white-labelled platforms, creating vertically-integrated models and removing another link in the customer chain.  The “1% all-in” world is no longer just a pipe-dream.

In summary

Advisers have many ways to cut their cloth to suit the nature of their client books and the set-up of their businesses.  When cost alone is not the primary answer to the question, it is incumbent upon us to understand and document what we expect from an actively-managed product which charges a premium for taking care of our monies.  Equally (and at the risk of straying into the world of “PROD”), fund manufacturers must also play their part in explaining the value that they offer to their target audience.  Indeed, in a world where discretionary fund managers and advisers themselves have become direct competitors, it is in their interests to do just that.  Tough markets, or simply lacklustre market returns, will only serve to intensify efforts to alleviate the end investor’s cost burden.

Article published in the Professional Adviser, Multi-Asset Review, June 2019.