You will have to pay various charges and costs whatever type of investment you buy. For example, if you invest directly in shares of a company such as Unilever, you will have to pay dealing costs and stamp duty. If you buy open-ended funds, investment trusts or ETFs, there will be several layers of costs to pay. Some are more explicit than others.
In the past, most fund charges were bundled together into an initial and single annual management charge. These covered the manager’s costs, commission to financial advisers and handling costs. A change in the law means that these charges have now been unbundled.
Nowadays, most people buy funds through platforms which have annual fees (see the guide to platform fees). Normally there is no extra charge for buying and selling funds but some platforms do levy dealing fees.
After that, you will pay an annual charge to cover the investment manager’s costs, which is deducted from the fund’s income or capital. This is typically around 0.75% on most actively managed funds where managers spend a considerable amount of time assessing the prospects of the companies they buy and sell. With passive funds, which follow indices, it can be less than 0.1% because less management time is required. Some managers also add extra performance fees if their returns exceed a certain level but these fees are relatively rare on funds.
On top of the annual charges, other expenses will be paid out of the fund such as regulatory, audit and legal fees, these can add up to 0.2% to the management charge. The total is known as the Ongoing Charges Figure (OCF).
In addition, there are transaction charges within the fund associated with the buying and selling of the fund’s investments, such as dealing fees and stamp duty. Currently, these charges are not disclosed to investors but the Investment Association, the trade body which represents fund managers, is currently working on proposals to provide this information in a meaningful way for investors.
In order to buy investment trust shares, you will normally have to pay dealing fees plus government stamp duty of 0.5%. Dealing fees are sometimes waived if you buy direct from the trust’s management company through its in-house investment scheme. Otherwise, the cost will depend on which stockbroker or platform you use. Not all platforms provide access to investment trusts.
There is also a bid-offer spread to take into account, which is the difference between the buying and selling price of a trust’s shares. This is part of the cost of investing. Virtually all investment trusts are actively managed. However, their annual management fees – the payment to cover the investment manager’s costs – can vary widely from under 0.5% to over 2%. Lower charges tend to apply on larger trusts which enjoy economies of scale, while smaller, more specialist trusts tend to have higher charges.
Additional recurring costs such as directors’ and auditors’ fees are included in the Ongoing Charges Figure (OCF) which covers all the regular running costs of the trust. Performance fees are not included in the OCF but should be taken into account, though their impact is often difficult to judge. Performance fees are more common in investment trusts than open-ended funds although, in recent years, some trusts have dropped these fees to make their charges more transparent. In addition, there are transaction charges within trusts associated with the buying and selling the underlying investments, such as dealing fees and stamp duty. Currently, these charges are not disclosed to investors.
Exchange-traded funds (ETFs)
ETFs are treated like shares so you will have to pay dealing charges each time you buy and sell. These charges will depend on which stockbroker or platform you use. However, no stamp duty is payable on ETFs. Not all platforms provide access to ETFs. There is also a bid-offer spread on ETFs, which is the difference between the buying and selling price, which is part of the cost of investing.
ETFs are generally passive investments that track various indices so the fund manager does not have to spend time choosing which assets to buy and sell. Therefore their management charges tend to be low, often below 0.5%. Other recurring costs such as administration fees, audit fees, custody fees and other operational expenses will be included in an Ongoing Charges Figure (OCF). There are transaction charges within an ETF which arise if the constituents of the index change and investments have to be bought and sold. Currently, these charges are not disclosed to investors.