Richard Butcher compares the hidden costs of investment management with boiler service plans
Imagine this situation. I buy a new boiler and with it take out a service plan – the latter paid for on direct debit. The headline charge for the service plan, the one included on the advertising blurb, is £10 a month. New boiler, lots of hot water, heating good to go when autumn finally kicks in and peace of mind over the costs. What could be better?
The first winter is bliss: a cosy warm house as the frosts sparkle on the lawn, lots of steaming hot showers after winter walks with the dog. Spring arrives and then summer and the boiler does its job. The next winter arrives and I send for the boiler man to do an annual service. He’s booked in, arrives, does his job and is gone again. Painless. Until I look at that months bank statement. There, in black and white, is a charge for £130 going out on the direct debit. I ring them up. This is the conversation:
Me “There seems to be a mistake. You’ve deducted £130 extra, that’s far more than the £10 monthly cost.”
Them “Let’s have a look sir. Yes I see. No that’s correct. Thanks for your call.”
Me “Hang on, wait a minute, what do you mean it’s correct. I pay you £10 a month for this work. Why have you charged me an extra £130?”
Them “Well sir, we charge £45 an hour for the engineer and then there’s a £30 call out arrangement fee.”
I don’t expect to pay extra when I need work doing
Me “What? What do you mean? I pay you £10 a month. I don’t expect to pay extra when I need work doing.”
Them “But sir, it is all in your contract. Did you read the contract we sent you? It is an industry standard. The £10 a month is our annual management charge – it covers our annual management service. You have to pay extra when you want something done that isn’t part of the annual management service.”
Me “Oh. No I didn’t spot that. But hang on, that still only adds up to £75. What about the other £55?”
Them “That includes £22 VAT – that’s a tax sir, we can’t not charge you tax, and £33 which was the cost of parts – these are small additional costs that we incur in the service that we are entitled to pass onto you.”
The key difference being that in investment management the deductions are less visible
This is, course, made up although not beyond the realms of the possible. In fact, not at all beyond those realms in investment management – the key difference being that in investment management the deductions are less visible.
Many trustees sign up to “industry standard” investment management agreements (there are no such things by the way) which include an annual management charge (although there is no standard definition of one of these) or AMC. They expect to pay the AMC.
They do, indeed, pay the AMC but they are also likely to be paying other costs – these being deducted from the return before it is passed on. The extra charges will fall into one of three buckets.
1. Other explicit costs. The manager may have a contractual right to charge for certain functions or services – for example, to provide frequent valuations of what you have invested with them or to attend periodic meetings. The list of additional explicit charges can be long.
2. Transaction costs. These are the costs incurred by the manager when buying, selling, borrowing or lending an investment. They don’t go into the manager’s pocket but they do come off the return. FCA has recently set out a framework for disclosing transaction costs – but it’s one thing to disclose them and quite another to control them.
3. Holding costs. These are the costs incurred while holding an asset. These costs are most acute in property investment and can include insurance and property management. There is no framework for disclosing these.
Unless trustees ask lots of questions they may find themselves in expensive hot water
Trustees do have a couple of controls over these costs: unfair contract terms regulation and treating the customer fairly, but both are weak. Unless trustees ask lots of questions, challenge and negotiate they may find themselves in, like me with my fully functioning boiler, expensive hot water.
Richard Butcher is managing director of PTL