21 January 2015
A wake up call for UK fund managers
Fund managers - whose job it is to invest people's money and make them a decent return - have had it far too good for far too long in the UK. The majority of investment funds charge a flat fee - typically around 1%, but as high as 2% or more in some cases. And, like estate agents, this commission structure means that fund managers cash in regardless of whether they do a good job for their clients.
If you've got £10,000 invested in a £100m fund that charges 1%, and the manager makes no return at all, he still gets paid his 1% of £100m - that's £1m a year from the fund, of which £100 comes out of your hard earned cash. If he loses you 10%, he still gets to cry himself to sleep on a £900,000 pay cheque, whereas your portfolio will be down £1,000 plus the extra £90 which the manager will take as his fee. Under this flat fee structure, the interests of the managers and the investors are not really aligned. If they were, there's no way we'd have a fund management industry where two-thirds of managers underperform the index.
And if any further proof were needed that the prevailing fee structure represents a bad deal for consumers, you need only look at the institutional market - where fund managers invest money for companies and pension funds. When dealing with professionals, fund managers are forced to offer a much keener deal - typically charging a very small flat fee (often as little as 0.3%), and only getting their big pay day if they meet very stretching performance targets.
While performance fees do exist in the retail market, they tend to be added on top of high flat fees - meaning the manager gets paid well if performs poorly, and gets paid extremely well if he performs strongly.
Aligning investors' and managers' interests
But a new proposition, launching this week, threatens to shake things up. Fund management company Orbis Access has created what are arguably the first retail investment funds to truly align the interests of manager and consumer.
Their funds will charge investors no management fee at all - unless they outperform their benchmark (ie perform better than the market). And if they underpeform, they'll even soften the blow by giving investors some of their losses back. If they outperform, then they take a generous performance fee of 50% of any upside. But this means that for the first time, investors will not be having to pay their fund manager, even when they fail.
It's important to note that if the Orbis Access team deliver significant outperformance, the investor will end up paying a hefty whack in charges - much more than they would have if they'd put their money into a flat fee fund that delivered the same returns. But in the world of investment, charges are the only certainty - and the appeal of the Orbis proposition is that you only have to pay them if the manager has done his job well.
If all fund managers were forced to adopt this model, half of the industry would be out of business in 10 years - which, frankly, would be no bad thing.
Orbis Access's proposition is designed for direct investors and, as a result, the company has built a clear and clean website, which is easy to navigate and easy to use. Like all investment funds, there are a small amount of additional costs that aren't covered in the regular management fee (such as the costs of trading the shares in the portfolio) - but unlike most managers, Orbis lets investors know about these, and gives them an estimate of how much they'll be - approximately 0.2% a year.
Importantly for us at Fairer Finance, the language on the website is simple, and there's good use of infographics and videos to bring complex concepts to life. They've not managed to create their terms and conditions and prospectus in quite the same vein - but I'm encouraged that when we pointed this out to them, they asked us to take a closer look at this for them, and seem committed to trying to create clear documentation as well - which would be another first for the investment industry.
The challenge for Orbis now will be making enough noise to get direct investors to come and use their service. Only a small percentage of people invest anything outside of their pension - and many of those who do, use an independent financial adviser to make their decisions for them. Nevertheless, after a sustained period of low interest rates, increasing numbers of people are looking for a better return than the bank can offer. And Orbis has every chance of attracting some of those who are ready to take on a little more risk than the savings account. There's also over £1bn invested in Virgin Money's tracker fund - where investors are paying extortionate fees for what they are getting. These are another pot of people for whom the Orbis offer should be interesting.
I genuinely hope it's successful. If Orbis Access can become a major force in the market, it will surely start to put pressure on other fund managers to think about charging their clients in a fairer way - and in 10 years time, we could all be getting a much fairer deal on fees.