Comment: Get ready for an onslaught of ‘shocking’ performance fees

I am not going to bore you with my applause for the FSA’s recent RDR proposals; anything that moves us away from the current system is going to get my vote, especially if it forces investors to ditch their myopia on commission-based fees and ‘encourages’ them to actually pay up front for decent professional advice.

My worry is the nirvana conceptualised by the FSA policy wonks may not actually happen – that wonderful new world might look like a British version of the US system where fees are driven down by careful, unbiased planners paid on a fees basis.

The FSA has quite rightly focussed on the cost of advice alongside the distribution channels because of course although returns are possible, even probable, costs are a dead certainty that drains total shareholder returns. Yet I think the proposals may actually produce the exact opposite result on costs imagined by the FSA – they may start to rise sharply as the nature of distribution channels change.

My worries on this subject were crystallised over lunch with Ed Moisson who spends his time poking about into the detail of cost structures for research firm Lipper FMI. Over the past few years Ed has been researching both the distribution channels used by asset managers in Europe as a whole and the charging structure. His conclusions raise some hugely disturbing issues for all of us looking to restructure the business of investment in the UK.

His first headline observation is that despite one of the most savage recessions in living memory not one major company to his knowledge in the UK outside of indexing products has chosen to radically cut fees as the basis for a marketing campaign. I have to say I find this astonishing. His rationale is that investors do not somehow see cost reductions a la Tesco as something that is appropriate in their minds for a fund product.

The next big observation is that in this brave new world where everyone tries to launch pan-European Ucits III funds the average TER has…INCREASED ! So as the industry scales up and goes Pan-Continental costs actually increase, in part because on the Continent the cost of channel distribution is closer to 70bps compared to our 50bps. Combine this with Ed’s well-established research that suggests the average UK based unit trust is already charging more in total expenses than it did 10 years ago and you see the trend is absolutely not the investor’s friend here.

But Ed’s killer point, in my view, is his work suggesting in Europe direct channels are virtually insignificant, and advisers a tiny part of the overall picture.
Most investors buy through the big banks and they pay through the nose for generally crap products with lamentable advice.

My real fear is the UK is about to go down this European road and not the American road. Investors are too mean to pay up front for advice and as IFAs struggle to make the shift, Renee and Joe Mondeo will simply go back to the High Street to buy the dross from the big banks.

And those big banks will want to sell this stuff as their existing traditional banking products come under margin attack – every major high street bank I talk to is readying yet another assault on the financial supermarket/bancassurance model. If they are successful we will be heading down the high fees route as fast as my cousins souped up Metro on a Saturday night in Harlow – with even worse advice than they already receive when it comes to investment products.

Ed Moisson’s analysis also prompts one last even more shocking revelation. As asset managers ‘struggle’ manfully with all these higher fees charged, they will also dream up ever more clever whizzes based around performance fees.

They will look at the shining example of the hedge funds (and many ITs) and come up with cunning plans that link the performance to barriers that are not barriers in essence.

My favourite has to be those clever guys that charge a performance fee based on one-to six-month Libor rates which means they get to 20% of anything above an enormous, gravity defying 1%- 2% gain (in addition to the existing 2% management fee).

This truly shocking stuff is coming at us fast and we need to be afraid… very afraid.

David Stevenson is a Financial Times columnist and consultant.

E-mail him at: davidcstevenson@gmail.