The cost of investing in funds

What you’ll learn:

• How ‘clean’ fund pricing works.
• What charges you might have to pay.
• here to find a list of charges.

Regulations that came into force at the start of 2013 overhauled the way consumers pay for investing in funds such as Unit Trusts and Open Ended Investment Companies (OEICs). The aim of the Financial Conduct Authority’s initiative, known as the Retail Distribution Review (RDR), was to give investors greater transparency. It makes it clearer how much they pay fund managers for running the fund and how much they pay any broker, investment service, or advisor who buys and looks after their holding for them.

The key outcome of this shake-up is that fund charges are now generally much cheaper and far more transparent.

But even with lower charges, some investors are disappointed by the impact investment costs have on their total returns. This is why monitoring charges is important - you need to know at the outset what costs you'll have to pay, then offset these against anticipated returns.

What are ‘clean’ share classes?

Asset management groups levy an annual charge for running a fund, which they deduct from the value of the portfolio.

Before the regulator’s overhaul this fee typically averaged about 1.5% a year for actively managed equity funds, while the cost was lower for passive or tracker funds. Fund managers generally paid part of this fee to brokers and financial advisers who sold their products - this was known as trail commission. But this ‘bundled’ fees structure meant the end investor had no clear idea of who was receiving what.

The RDR opened up ‘clean’ or ‘unbundled’ share classes, which include only charges for running the portfolio. So now the fund manager charges you one fee paid from the fund, while an intermediary or broker charges you another. If you take financial advice, or invest through a website, you pay a separate fee to them, but even with the two charges combined, you should be getting a better deal than before.

In addition, there are now ‘super-clean’ or ‘preferential’ share classes, which describe funds where brokers have negotiated special deals with management companies to access even cheaper share classes, reducing the costs yet further.

The result of these changes is that fund fees are a lot cheaper. For example, today a fund manager might charge just 0.75% for an actively managed equity fund and even as little as 0.1% for a passive portfolio.

Find out more about active and passively managed funds

Unpicking the charges

When it comes to selecting funds, you need to ensure you understand the jargon that comes with the territory. Below we highlight the main charges and what they mean.

1. Annual Management Charges (AMC) - as the name suggests, this is a measure of the costs over the year relating to the fund's management. The AMC is deducted from the value of the fund and is calculated into the price of the fund each day. However the AMC may not include all the other sundry costs
2. Ongoing Charges Figure (OCF - sometimes called an OGC) was previously known as the Total Expense Ratio (TER). This figure is a far better representation of your actual expenses because as well as the AMC, it includes the main ongoing costs that were taken from the fund in the previous year. You can use this information to work out the impact these costs will have on your returns. If a fund’s OCF for example is estimated to be 2.5% and it returns 5%, the amount you'll profit by will be cut back to 2.5%
3. Sundry fees and charges - investors will also be charged for other expenses incurred by the fund including a charge for the trustee or depositary (those overseeing the manager's activities and those holding the fund's assets - audit fees, registration, regulatory and legal fees). You’ll have to research whether the sundry fees are included in the AMC and/or the OCF. If you've chosen an actively managed fund, ask about performance and trading fees

Where will I find the list of fund charges?

Most funds issue a Key Investor Information Document (KIID), or otherwise a Simplified Prospectus, which outlines the fund's key features and charges. You must confirm you’ve read this document before you place any fund purchase. You should look to the KIID for the fullest detail on the costs you might pay through the fund manager.

The one-off charges that may be taken when you buy or sell are listed as entry and exit charges, although through Smart Investor you’ll rarely have to pay these. Next will be the charges taken from the fund over the course of a year - so the OCF expressed as a percentage - followed by any other charges taken from the fund under specific conditions, including a performance fee if one is charged. Performance fees are charges taken if a fund’s investment return is better than a specified level or benchmark. You should also check the accompanying text for any other fees that may be applied in specific circumstances.