Why is £268,000,000,000 earning almost no return?
Why does £268 billion sit in Cash ISAs earning almost nothing?. Out of the 22 million ISA investors there are more than 15 million cash only ISA subscribers, of whom 60% made no further subscription in the latest year for which data is available from HMRC . This suggests that these were fairly permanent investments and not just short term liquidity management.. Furthermore the personal savings allowance allows interest of up to £1,000 tax free for a basic rate taxpayer, so at today’s rates you would need in excess of £100,000 to get the maximum benefit from that. So what on earth are all those millions doing in ISAs anyway? Not for the returns for sure. Over the five years 2016-2020 the compound total return on a cash ISA based on typical savings deposit rates would have been 6.2%, a return less than half the increase in CPI in the same period. But over that same period a median actively managed balanced fund from a leading provider would have given a return of 40% and from a leading provider of ETFs also 40%.
The whole process is too complicated
Although in reality most savers do invest into funds indirectly, in the US, the UK and Australia, through retirement products that in turn use funds as ways of investing, small retail investors who invest directly into funds, for example in an ISA, are in decline worldwide for a variety of reasons. It’s because the process has become very forbidding for the average person. Look at the multiplicity of blather from experts, advisers, fund selectors, recommended lists, sites and platforms that give guidance (or is it advice) on investing. And the regulatory minefield that has been laid to trap advisers who don’t go through the whole palaver of KYC, fact finds, best advice, suitability and so on; and the FCA’s most recent hoop for firms to jump through ‘A new consumer duty’. For small investors it has become an almost impenetrable jungle of jargon. Opening an account with a commission free online broker and buying a hot stock is quick and easy and a lot more fun.
The fund management industry has failed
It all comes back to who pays and how. Prior to the RDR ban on commission payments an investor might pay a 5% initial charge and a 1.5% annual charge and the fund management company paid a commission to the adviser when the transaction was made. Now the investor agrees the cost of initial and ongoing advice and pays the adviser directly or the payment can be ‘facilitated’ by a request from the client to the fund management company to deduct the agreed payment from the investment. All transparent the client pays or is it a commission?
A chat about facilitation
“Now, Mr or Mrs Investor, you know that there will be a charge for my advice, which I must disclose to you”
“Fine, I expected to pay for your advice”
“So, I use a time cost basis, and I reckon I will have spent four hours on our first meeting, then the initial fact find, the analysis of your needs and the selection of investments that meet your wishes to be environmentally friendly and go for long term steady growth, and the recommendations report. At my hourly rate of £250 that will be £1,000”
“Blimey!”
“ You can pay me by bank transfer. 0r,there is another way.”
“You mean I don’t have to pay you £1,000 now?”
“That’s right, you can simply ask the fund manager to deduct £1,000 from your initial investment and then pay that amount to me”
“Sounds reasonable .
“And you would probably like me to do an annual review and provide some ongoing advice?”
“Yes, please”
“For that my charge is only one percent of the value of your investment portfolio which can be paid by asking the fund manager to redeem some shares and pay me”
“OK”.
The best kept secret
According to the FCA 90% of clients use the ‘facilitated’ option where there is an initial charge of 1% to 3% for the advice and 0.5% to 1% annually for ongoing advice. Yes… facilitated advice is one of the great secrets that keeps the expensive advice industry alive.
But that is not the end of it. A long value (or rather cost) chain of organisations has been created, all of which may take their little slice. The total cost of investing is going to be something like 2.25%, composed of the investment management fee of 0.75% charged by the management company, the platform fee of 0.5% and the adviser fee of 1.0%%. That is 0.75% more than the old bundled fee of an average 1.5%.
Back to the small investor. While £1,000 deducted from £50,000 to invest may not sound too off putting, £1,000 or even £500 deducted from a £ 5,000 investment is pretty steep. £150 might be a reasonably acceptable payment. But an adviser still has to go through the regulatory routine of a KYC and a fact find and a suitability assessment. So it will not be worth bothering with the little guy and there are clear indications that a small investor is simply not willing to pay an economic price.
Many commentators agree
Two good comments that we have derived from our recent research into the breadth and depth of development of investment in funds by small investors in several countries.
“These innovations (platforms and direct investment) were are not able to attract retail investors in formative years. We ourselves have created such a complex ecosystem that even the most intelligent investors find it difficult to invest in mutual funds directly.”
Dikkatwar Ramkrishna, Innovations & Technology Based Initiatives in Mutual Fund Distribution Intermediation in India
“Retail investors are not highly engaged with funds management. There are many intermediaries between fund managers and retail investors. This long, complex value chain creates issues regarding incentive alignment, transparency and conflicts of interest. This is despite the apparent competitiveness of the funds management market itself. “
Competition in funds management, Australian Securities & Investments Commission March 2021
Investors don’t have to pay advice fees
But many small investors without complex finances are beginning to find that it’s not that hard to avoid the expensive advice rigmarole by making their own common sense and pragmatic decisions, and execute either directly with a fund management company or with a robo adviser or with a no fee online broker. And, anyway, research seems to suggest that advisers are not trusted and regarded as too expensive.
New ways will take over
Some leading fund management companies are showing the way with no entry or exit charges and reduced ongoing charges for direct investors, as low as 0.65% in the case of M&G, with no minimum. There is no advice so investors will need to make their own choices. No need for expensive KYC and suitability assessments then. Wealthify is a low cost robo adviser using ETFs with charges of 0.76% including the fund’s management charge and no minimum; you don’t pick your own funds, since these are packaged up in a series of portfolios. Vanguard, as always a disrupter, has recently launched its pension advisory service for an all in fee of 0.79%. But you will need a minimum of £50,000 to be accepted. And many others to come I suspect.
Fintech will play an increasing role. To see a vision of the future just take a look at China, whose potential should never be ignored. I remember when people said that China could only make little plastic umbrellas to put on top of cocktails. Really? In China now investment in funds has moved from expensive high pressure sales through banks to direct online in a single leap, thanks to the famous Yu’e Bao money market fund which habituated tens of millions of small investors to choosing and making their own direct investments using mobile devices.
Time for a rethink
For anyone involved in the top heavy British fund sales chain who wants to lose sleep, this will all repay careful study and perhaps an alternative strategy. Platforms maybe roaring ahead now, but in the longer term the sales and distribution structure with its complexity, conflicts of interest, and high costs will most likely go the way of bank branches or indeed physical shops in the high street. It’s tough to break into well-established sales channels and you need deep pockets to cut prices when you employ a bunch of expensive managers; but once the word gets around the new ways for investors to make decisions and execute will gather pace. And small investors will once again be welcomed rather than shunned.
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