Fund firms could be forced to deliver ‘wealth warnings’ about charges in future, after City watchdogs tested the effectiveness of alerts on hundreds of investors.
Savers are more likely to buy cheaper funds when investment costs are explained better and more fully than they typically are now, their new study found.
A battery of tests looked at whether a standalone warning banner, a chart showing how charges drag on returns, a comparison with rival fund fees, and a rundown of costs just before purchase, would prompt investors to choose a cheaper fund.
Wealth warning: More than one thousand investors took part in tests to find out if new alerts and messages about charges would work
In all the above cases, people were more likely to select cheaper funds – while still taking into account other important factors such as performance and risk – than when they only got the limited information fund managers reveal at present.
New watchdog rules have already forced fund firms to start disclosing single, all-in fees in pounds and pence at a bare minimum, in an attempt to make investing costs more transparent. Fund providers will also start having to prove they are offering clients value for money under a tougher regime from next year.
But the Financial Conduct Authority’s latest research suggests it could go a step further in future, and compel fund firms to display more prominent and useful messages about charges.
For now, the watchdog said firms should consider its new findings when thinking about how their charges disclosures are working.
But it plans to feed the results into its current study of DIY investing platforms, and said it would ‘consider changing rules and guidance to mandate certain forms of disclosure’ in light of them.
What happened when investors were given alerts and fuller messages about fund charges?
More than one thousand investors took part in tests on a mock online investing platform, which was made to look as much like the real thing as possible. See the picture below for what the web page looked like.
How was mock investing site created?
‘We designed the experimental environment carefully to make sure that it replicated the most important features of online investment platforms as closely as possible,’ said the FCA report.
‘This included the information provided, how participants could navigate through it and its general look and feel. We created mock-up pages which we tested in our focus groups and pilot.
‘This ensured they were as similar to investors’ expectations as possible and that they captured all the information which investors would require to make an investment decision.
‘In total we created 90 fund sets which participants were randomly allocated to in each of the three choice experiment rounds. The order of the funds was also randomised to prevent participants being able to identify any patterns and to control for any ordering effects.
‘We also used fictitious fund names to avoid associations with popular brands and randomly allocated these to funds.’
The investors involved were the financial decision-makers in their households, had invested in an actively-managed investment fund before, and had at least £10,000 of assets available to invest, but they had not paid to use a financial adviser.
The mock investing platform offered six fictional funds, with charges displayed to mimic the way they usually are now on DIY platforms and fund provider sites.
Annual performance for the last five years and risk categorisation was also given, and you could read further fund details by opening pop-ups.
The pop-ups contained two pages of detailed information including fund objectives, asset allocation, and a table showing a breakdown of costs and charges in both pounds and pence and as a percentage.
The investors were divided into five groups, who were all shown the mock site and asked to pick one fund to invest in during the tests.
But one group only saw the basic site, while four other groups were given different information and messages about fund charges during the process.
Immediately afterwards, the FCA surveyed everyone to find out what impact the various tests had on people’s awareness and understanding of fund charges and their importance.
1) Control group: This cohort was only shown the mock site below, which was meant to simulate how charges are shown now, and asked to pick a fund from those available.
Mock investing site: All investors were shown a simulated online platform and a range of fictitious funds
2) Warning: Investors were given a warning reminding them to check how much they were paying and that charges can have a significant impact on their returns. It appeared at the top of the page containing the six funds. See what it looked like below.
3) Warning and impact chart: This group saw the same warning as above, as well as a graph illustrating the impact of a small difference in charges on net returns over time.
‘The impact of compounding of fees over time is an important factor which many investors may not understand or consider in their investment decisions,’ said the FCA. See below.
4) Warning and comparator chart: Investors could see a chart comparing a fund’s charges to others in the same asset class when they opened a pop-up page.
‘We designed this treatment to help participants understand how each fund’s charge compared to others in the same asset class. They could also easily identify if a fund’s charge was more or less expensive than average.’ said the FCA. See below.
5) Warning and review screen: Once investors had selected a fund, a summary of its costs and charges as well as the comparator chart in 4) appeared. They could then either confirm their choice or go back to look at the available funds again.
‘We designed this treatment to provide participants with charges information on a screen which they had to view before proceeding as we know that where information is provided can have a significant impact on the attention consumers give it,’ said the FCA.
‘This treatment also provided participants who might not have considered their initial decision carefully enough with an opportunity to make a more considered decision.’ See below.
What were the results?
All the groups that got extra information on charges were more likely to pick cheaper funds than those who only saw the basic site. However, the messages given to groups four and five proved most effective.
Number crunching: Percentage of investors in the control group and other test groups who selected one of the cheaper funds
‘The warning and review screen [group 5] had the largest impact on decision-making. It led to a 10.5 percentage point increase in the proportion of participants selecting a cheaper fund,’ said the FCA.
‘This treatment also led to an improvement in awareness and understanding as measured by our survey questions. For example, we found a 11.3 percentage point increase in the ability of participants to recall how the charges for their chosen fund compared to the others they were shown.
‘The warning and impact chart [group 3] also had a significant impact on decision-making but a more limited impact on participants’ awareness and understanding.’
The FCA said the warning and comparator chart [group 4] had an impact on the likelihood of investors choosing a cheaper fund, but in this test the chart was only placed on fund specific pages which fewer than half of participants clicked on.
When the comparator chart was placed on the fund review page, which people had to look at after choosing a fund [group 5], it had a much larger effect.
The FCA said the standalone warning put at the top of the page [group 2] also seemed more effective when combined with either the review screen or the impact chart.
The watchdog added: ‘Although some of our treatments led to participants selecting cheaper funds, it appears they did not change the attention they placed on other fund characteristics including performance and risk.
‘The proportion of participants selecting high performing funds in any treatment group was not statistically significantly different to the control group. We also found similar results for low and medium performing funds.’
Closer study: The tests didn’t have much effect on whether investors were likely to pick high performing funds
The FCA admitted its experiment was limited because it could not use real brand names for funds.
‘Brand is an important consideration to investors when selecting a fund. Although we included fictitious fund names, for legal reasons, we could not include brands in the experiment. We know that investors typically report brand and reputation as being factors they would consider when selecting funds.
‘In our survey, 21 per cent of participants stated that seeing a particular brand would have affected their choice of fund.’
In the survey, investors were tested on their understanding of charges and financial literacy in general, asked to rank the factors which were most important to them in choosing funds, and questioned on whether brand names would have had an impact on their behaviour, and if they would have invested in their chosen fund in reality.
FCA made the following further points about its research.
* When it came to the education level of participants, it found the proportion of investors choosing a cheaper fund did not significantly differ between those with or without a university degree. However, the warning and comparator chart [group 4] had a particularly strong impact among those with a degree.
* It gave investors an incentive to take part in the tests, but did not reward participants who chose one of the cheaper funds in case this encouraged people to behave how they thought they should, rather than actually would in reality.
* When people were asked whether they would actually invest in their chosen fund, the proportion of investors who said would not was around 40 per cent, and this was no different between the control group and the others who saw various messages on charges.
* Among those who would not have invested, 16.7 per cent said they required more information and 10.4 per cent said they did not recognise any brands. Asked what they would do with the money instead, 24.9 per cent said they would invest in another type of fund and 14.1 per cent in another type of asset.
Why is the FCA concerned that investors take account of fund charges?
‘Why do charges matter? It is important that investors take charges information into account when selecting funds. Charges act as a drag on performance and impact the return which investors actually receive,’ said the FCA report.
‘While performance is volatile and the consensus is that past performance is not a good indicator of future performance, investors will always incur charges. Due to compounding, over time, a seemingly small difference in charges can have a significant impact on returns.
How much do fees hurt?
Research by consumer group Which? shows that if you invested £10,000 in a fund with no charges and it grew by 6 per cent annually for 20 years, you would get a return of £32,071 – just over £22,000-worth of growth.
However, if that fund had a charge of say 1.67 per cent your return would be reduced to £23,344. Around £9,000 of your growth would have gone on charges.
Check out our fund charges calculator here. If you input the size of your investment and your charge, it will show you the impact.
‘Some investors might choose to invest in funds with higher charges in the expectation of achieving higher returns. However, research from the US has suggested that cheaper active funds deliver higher returns than more expensive funds in the same investment category.’
The FCA said its own analysis found no clear relationship between charges and gross performance for actively funds in the UK, but there was some evidence of a negative relationship once charges were taken into account.
‘This suggests that when choosing between active funds investors paying higher prices for funds, on average, do not necessarily achieve better net returns,’ it said.
The FCA also found weak price competition in a number of areas of the asset management industry, with high levels of profitability across its sample of firms, considerable price clustering for active funds, and little evidence that firms compete on the basis of price.
‘This suggests that drawing attention to charges, alongside other factors such as performance and service, might allow investors to drive more effective competition between asset managers.’
The FCA said that its previous consumer research has shown that investors’ awareness and focus on charges is mixed, with a significant number of investors unaware that they were even paying for fund manager services, and fewer than one in ten investors seeking out charges information while browsing an online investment platform.
It also found investors are prone to investing in funds that are unlikely to deliver good value for money, including putting £109billion in active funds which closely mirror market performance – popularly known as closet trackers – but are much pricier than passive index funds which will clone market performance automatically and cheaply.
When it came to the cost of passive funds, the FCA cited academic research that showed considerable numbers of investors select ones with high charges, when cheaper alternatives were available that were almost certain to generate higher returns.
How do you find out fund charges?
New watchdog rules mean fund firms now have to cough up full details of investing costs, including transaction costs and administration charges, in a standardised format.
Transaction costs were traditionally excluded from the ‘ongoing charge’ given to investors, though transparency campaigners say they add significantly to total costs
The ongoing charge is the investing industry’s standard measure of fund running costs. It should be found on companies’ fund documents used for marketing purposes.
But one of the easiest ways to track the figure down is on the short and standardised Key Investor Information Documents (KIID) that all firms must produce for each of their funds.
Links to KIIDs can be found on fund analysis sites like FE Trustnet, and some DIY investing platforms carry them alongside individual funds.
You can also put the name of a fund and ‘KIID’ together in an internet search engine. The ongoing charge typically appears at the top of page two of a KIID.
The FCA offered the following behavioural reasons for why investors might not pay enough attention to charges.
1) ‘Investors have limited attention spans when making investment decisions. The prominence that information is given can have a significant impact on how much investors focus on it. For example, information located on the top of a page is likely to be more effective than that at the bottom of a page,’ said the FCA.
It cited one study that found firms might have an incentive to make their charges more complex or less transparent to reduce competitive pressure, and another that claimed only a small fraction of fund advertising is informative about important characteristics like fund fees.
2) ‘Investors might find it difficult to understand and compare information on charges. When faced with complicated decisions and lots of information, consumers often use simplified decision-making mechanisms to make choices.
‘So more information will not necessarily lead to better decisions. The format in which charges information is provided can affect how likely it is that investors will pay attention to and understand the information.’
The FCA quoted a study showing investors can make better investment decisions when presented with charges in pounds and pence rather than as a percentage.
3) ‘Investors might mistakenly consider small differences in charges to be unimportant when making investments. We know that due to compounding, over time, even a small difference in charges can have a significant impact on net returns.
‘It has been well documented that investors might struggle with even basic financial calculations so they might not appreciate the impact of charges on returns over time.’
4) ‘We know that many investors pay attention to past performance (which is net of charges) when selecting a fund. There is evidence that some investors may focus more on past performance than charges when selecting funds, believing that funds which have performed well in the past will perform well in the future.
‘This belief is not supported by UK academic analysis, which has found that the majority of funds with historical outperformance do not continue to outperform the relevant market index or peer group for more than a few years.
‘This suggests that some investors could incorrectly assume that past performance will continue (this is known as extrapolation bias). They may pay too much attention to past performance, possibly at the expense of other important factors such as charges.’
What was the response to the FCA’s findings?
‘It is good to see that the FCA finds how important it is to disclose costs and charges in a clear and meaningful way, as this leads to consumers buying cheaper funds,’ said Gina Miller, a campaigner for transparency on investment costs and co-founder of wealth manager SCM Direct.
‘They have also found, apparently in some magical “now you see it” moment, that costs alone are not the biggest buying trigger.
‘Through our True and Fair Campaign, we have always said that consumers need to see the true level of costs, then balance this with the likely risk and return.’
Miller called on the FCA to investigate whether fund firms were complying with new rules brought in this year on the disclosure of charges.
She also wants the FCA to set up a taskforce to create a compulsory common costs and charges template to be used industry-wide.
Miller said SCM Direct would consider legal remedies, including seeking a Judicial Review, on the grounds the FCA was failing ordinary consumers by not ensuring a competitive industry.
This is Money asked the FCA and fund industry group the Investment Association for comment on Miller’s statement, but neither responded.
Last week, the IA welcomed the FCA’s latest rules aimed at protecting investors, saying: ‘Our industry is committed to demonstrating, and delivering, good value to the millions of people who entrust their savings to us.
‘We welcome the FCA recognising that people judge their asset manager by investment performance and service, as well as cost.
‘We strongly support a greater emphasis on communication as well as governance to help customers better understand what they are investing in, what they are paying for and what they are getting in return.
‘The IA is already working with the FCA in these important areas and looks forward to continuing this in the coming months.’