The truth about investment costs

The authorities have been trying to tackle this issue and protect retail clients who they feel are most at risk of paying ‘hidden costs’.

Last year the Financial Conduct Authority and Department for Work and Pensions launched a joint initiative to get to the bottom of transaction costs for workplace pension schemes.

That project has yet to publish a conclusion, however, and perhaps the reason is that investment costs are so notoriously difficult to pin down.

In fact, if trustees and scheme members really understood the fees their investments generated, would it put them off investing at all?

Take the example of a simple bond investment. Almost all bonds trade on a spread, which means they have a ‘buy’ price and a ‘sell’ price.

The mid-price is the price that valuation systems generally pick up and report, which means the instant a bond is bought a loss is recorded, being the difference between the buy price the mid-price.

This ‘bid-ask spread’ is in practice a fee that market-makers charge for service they provide in making a market for the bond.

But what exactly is the fee that you have paid? Unless the exact same bond is sold at the moment in time you buy it, it is impossible to know what that fee is – it can only be estimated.

Other fees and charges are more transparent – such as a custody or platform fee for holding the bond and a management fee for managing the portfolio or fund.

But often managed funds wrap up these fees in a single figure and may not keep track of other transaction costs at all. That makes it very difficult to calculate the real costs of fund switches or trading.

This opacity is a significant contributor to the distrust many investors feel toward financial institutions, and is another reason workplace pension schemes are hesitating to form closer ties with investment managers at a time when greater collaboration is desperately needed.

Bob Campion is head of institutional business and business development at Charles Stanley