The fee squeeze

    Regulatory scrutiny, such as MiFID II and Prod suitability, has brought increased pricing discipline and much needed transparency on DFM fees, enabling advisers and their clients to see how the fees they are paying compare to others in the market. The general trend is that costs are now falling, albeit only a gradual decline- but is a gradual reduction good enough for advisers and clients in the current climate? 

    With low growth ahead as a result of the COVID-19 crisis, and its impact likely to last months or years to come, DFM costs remain under the spotlight and notably higher fee charges are not so easy to justify when returns are low. With this set to continue, how will fees be impacted in the future?

    More efficient portfolio design

    A central element of DFM portfolio cost is in its design. The IMX portfolios have been set up to achieve good value for money without sacrificing investment principles and overall objectives. To achieve good diversification and access to the asset classes needed to achieve the objectives, they use some funds with higher fees. This is balanced, wherever possible, with low cost, efficient index-tracking funds in other asset classes.

    As we know, the cost of active funds can be significantly higher than the cost of passive funds. In some cases this can be shown to add value and represent an important portfolio ingredient, but historic evidence shows that in many areas active managers tend to perform no better than the benchmark index before fees. Of course, there are some managers who do perform better, but identifying which managers will outperform in the future, given uncertain market conditions and events, is tricky, and even managers who have long successful track records may underperform in different market conditions in the future. For that reason, we focus on using passive management where we do not see strong evidence that active management can consistently and predictably outperform the passive benchmark. 

    There are some areas where we believe active management can add value, for example, in multi-asset credit and some property mandates, and we consider those asset classes to be better managed actively. The IMX portfolios use a small number of actively managed funds, where they can be expected to add value, but with cost effective passive funds used elsewhere. This helps to get the best value for money and avoid unnecessary fees where they aren’t expected to help performance. 

    We have also demonstrated the benefits of using a multi-factor approach combined with effective diversification in our previous articles.

    Even relatively small fee savings (for example, by replacing some expensive actively managed funds with lower cost funds) can have significant effects over time. Hymans Robertson developed a tool called Track and Go which illustrates how much you can plan to withdraw from an investment in each year. This shows the impact of higher and lower fees on the expected amount that can be withdrawn each year. For example, if it’s possible to save 0.2% a year on fees for someone withdrawing from a pot of £500k over 30 years, their annual income could be £800 a year higher, or their pot at the end of the 30-year period could be £50k higher (allowing for the effects of compound interest). 

    Buying power and operational costs

    Institutional buying power may mean that costs can be brought down further. This can encourage more competitive pricing from asset managers, while smaller scale DFMs tend to be more limited in their buying power. For DFMs there are other cost considerations too. Well-run DFMs need to ensure robust governance in their stewardship of portfolios – leading DFMs may have efficient and experienced management frameworks to ensure this but can still do so cost effectively. Others may be burdened by the costs of meeting their full obligations. Similarly, a DFM should have a strong and efficient operations function.  Expertise and sophistication of operational processes can vary between DFMs – efficiencies here can also impact overall fees passed onto the client. 

    These functions will come under increasing scrutiny. Advisers are dealing with high flow of retiring clients sensitive to late accumulation growth. At the same time, advisers are shaping the propositions they want to deliver more clearly, with consideration for Prod and the suitability of investments for particular client types. Early 2021 will see the FCA communicate greater expectations in this area too – well-judged sustainable withdrawal rates and centralised retirement propositions will all stand up better with lower fee burdens.

    The IMX advantage

    Using best practice methods to minimise costs has been central to the formation of IMX. The resulting distinctive proposition is very efficiently run to keep IMX DFM fees low, with a clear underlying portfolio design. IMX can deliver these efficiencies for Nucleus advisers in three ways:

    1. Fund implementation - Hymans Robertson’s position as an adviser to many institutional investors provides institutional buying power, and their existing relationships with the asset managers offers opportunities to access lower-priced funds. The way in which IMX portfolios are designed can bring even more cost efficiencies.
    2. Governance - The portfolios, underlying funds and managers, are closely monitored by Hymans Robertson on behalf of IMX as part of a proactive governance structure. Hymans Robertson has a long history of providing institutional fund advice and knows the asset managers well. This means they can monitor the funds and managers efficiently and adopt new ideas or changes to IMX quickly. Their experience can also help to identify areas where costs can be reduced, and where it is worth spending more to enhance performance. The monitoring and decision frameworks ensure cost efficiency in delivery as well as aiding overall portfolio performance.
    3. Administration - Nucleus has extensive experience in platform trading and oversight, with a mature operating model. This expertise is also now harnessed in how IMX portfolios are administered on a discretionary basis, bringing higher levels of efficiency and lower costs for the IMX service.

    The future of fees

    While uncertain times can make predictions difficult, there is a growing case for more disruptive pricing in the DFM marketplace. Good client outcomes will depend on quality of investment proposition and minimised fees to flourish in a low growth environment. At best this is a significant short-term problem. Yet adviser expectations are rising here too, and the regulator is following close behind. Further pressure on fees seems inevitable.

    It may prove to be the case that only some DFMs will have the capabilities and efficiency to respond and move the market forward on price. The IMX proposition has been established with the right foundations to make this possible, and sustaining quality at low cost to the customer will remain our core aim.

    Richard Allen

    Partner, Hymans Robertson

    Risk warning: This communication has been approved and issued by Hymans Robertson LLP (HR) on behalf of Hymans Robertson Investment Services LLP (HRIS) and is based upon their understanding of events as at date of publication. It is designed to be a general summary of topical investments issues, it does not constitute investment advice and is not specific to the circumstances of any particular financial advisory firm. Please note where reference is made to legal matters, HRIS is not qualified to provide legal opinions and you may wish to seek independent legal advice. HRIS accepts no liability for errors or omissions.

    Please note the value of investments, and income from them, may fall as well as rise. This includes equities, government or corporate bonds, and property, whether held directly or in a pooled or collective investment vehicle. Further, investments in developing or emerging markets may be more volatile or less marketable than in mature markets. Exchange rates may also affect the value of an overseas investment. As a result, an investor may not get back the amount originally invested. Past performance is not necessarily a guide to future performance.