In search of lower charges

Amid all the anxiety about inflation over the past couple of years, it might have escaped your attention that prices have actually been falling in one area. Step forward investment trusts, which continue to cut their charges. Remarkably, more than half of all funds have reduced the fees they levy over the past decade.

Next month’s merger between Witan and Alliance Trust will provide yet another example of this trend. The two funds currently levy ongoing charges of 0.96% and 0.62% respectively, but part of the rationale for the deal is that the additional scale of the combined entity will enable fee reductions; the headline charge on the new vehicle is expected to drop below 0.6%.

For many years, financial advisers, analysts and journalists talking about investment trusts would almost automatically state that they were cheaper than open-ended funds. The latter’s charges incorporated commission payments to intermediaries, so they were typically more expensive – though, somehow, intermediaries receiving those commissions often seemed to overlook this.

Then, in 2013, regulatory reforms outlawed commission payments across the investment industry and open-ended funds were able to cut their fees accordingly. This was actually a boost for investment trusts, which had never been allowed to pay commissions; the sector started to get more attention from advisers now that it was competing on a level playing field for their clients’ business. But the changes did mean investment trusts no longer had an automatic cost advantage.

The result has been something of a price war – good news for investors. As open-ended funds cut their charges in the wake of the ending of commissions, investment trust boards responded, reducing their fees too.

Are investment trusts always still cheaper? Not necessarily. But Boring Money, the personal finance website, reckons they very often are. Stripping out passively-managed open-ended funds, where costs are very low, the average open-ended fund charges an annual fee of around 0.95%, it says. The comparable figure for investment trusts is around 0.65%.

That’s quite a difference. It means you’ll be paying a third less in charges each year with a typical investment trust. Stick £20,000 a year (the value of the annual individual savings account allowance) into a fund with an annual fee of 0.95% and you’ll pay total charges of £16,204 over 10 years assuming you earn an average annual return of 6%. At an annual fee of 0.65%, by contrast, total charges come in at only £11,190.

The other point here is that charges are the one thing you can control when you’re deciding where to invest. You can make some educated guesses about which funds will deliver the best investment returns, but future performance is essentially an unknown. Information on charges, by contrast, is available upfront.

This is important. In the example above, the more expensive fund would have to outperform its cheaper rival by at least 0.3 percentage points every single year to overcome the effect of its higher charges. Investors confident that it will deliver that outperformance may be happy to pay more – but it’s inevitably a gamble.

Don’t get obsessive about charges. Fees are just one factor that you should consider when choosing an investment. But they certainly should be a consideration – and very often, investment trusts have a competitive edge on this point.