Why do fees exist?

One of the main reasons for appointing a professional to manage your investment portfolio is the expectation of the higher investment return they ought to be able to generate than you would be able to if you tried to invest your money yourself. For this end result, most clients would be willing to pay a fee. However, this is not as simple an equation as it may appear at first.

There will be an upfront annual management fee from the private asset manager. This is usually on a sliding scale, based on the volume of investible assets you are placing with the manager. The more you invest through a firm, typically the smaller the fee you pay. Also, while most firms have a standard fee schedule, many will say that this is open to negotiation especially for larger value clients investing bigger sums.

Some clients may assume that this represents all of the costs they will incur. However, there are a number of ¬Ěcosts of investment, which can diminish the return, of which many clients are not immediately aware.

According to the UK's True & Fair Campaign in 2018, which works to make the sector more transparent in declaring fees and charges, 45 percent of UK clients do not know how their investments are performing and nearly a third, 29 percent, do not know what they are being charged.

These charges can include custody costs, dealing commissions, administration costs and fund charges, as well as platform costs and exit charges.

Dealing commissions, incurred when a manager buys or sells a stock, are also often hidden. These can mount up, especially if a manager is frequently making changes to the portfolio.

These hidden costs can eat into the additional returns that an investor should be able generate. It is important for you to be clear on what you are paying for from the outset and carefully monitor ongoing and additional costs, to ensure you are receiving good value and the maximum possible returns.

Since the introduction of MiFID II in 2018, the picture has become clearer for clients. However, fees are still not fully transparent. The Financial Conduct Authority (FCA) is introducing Consumer Duty regulation in June 2023 to help improve transparency.

Active versus passive fees

One way clients sometimes try to reduce their fees is investing through passive vehicles such as Exchange Traded Funds (ETFs). More information can be found in chapter six.

These types of vehicles continue to grow in popularity and the cost advantages is one reason for this.

ETFs or similar products do not make tactical asset allocation calls. Instead they track an index. This means that many of the hidden costs, or any manager performance fees, are not applicable. In most cases the fees for an ETF are much lower than for other funds.

There are also concerns that many actively managed funds are in fact closet index trackers. These are funds that claim to be actively managed and charge accordingly, when in fact they closely mirror the performance of an index.

The European Securities and Markets Authority (ESMA) claim that between five and 15 percent of UCITS equity funds in Europe could fall into this category. The real number could be even higher.

If this is the case, then many investors are paying for the opportunity to achieve alpha, which they will not receive. At the same time, they could obtain the same returns at a lower costs by using passive investment vehicles.