Personal Finance: It's an expensive business

My comments last week about the costs charged by unit trusts seems to have struck a chord with several readers. Many of you have expressed surprise that there is no formal requirement on funds to disclose their total expense ratios, as opposed to their annual management fee. Most investors naturally assume that the annual management fee includes all the costs that they are going to be charged.

But it is not so. It is true that the extra costs charged are relatively small. The average extra cost is only 0.21 per cent for all UK funds (average management fee 1.18 per cent, average total expense ratio 1.39 per cent). But the average conceals a wide variety of different experience.

It is striking how widely the add-on costs can differ from group to group. In any event, as the analysts at Fitzrovia International point out, even 0.21 per cent equates to a 15 per cent increase in the cost borne by investor. The cumulative effect over several years can still be striking.

The tables shown here summarise the findings. One lists the fund management groups with the highest and lowest total expense ratios in Fitzrovia's universe of equity funds (the data excludes groups which have fewer than three distinct funds to analyse).

It throws up some anomalies, though as I noted last week, a group with a high total expense ratio (such as Jupiter) may well be able to claim that its higher costs are justified.

Most groups with strong track records will tend to try and charge 1.5 per cent per annum as a management fee, this being about the most that the UK market seems willing to bear.

There is a comparison to be made between different funds. Equity funds are the most expensive, on average, but at least it is possible to lay claim to superior performance, even if only a minority beat the market averages over time.

There is no such excuse for bond and cash funds. As Paul Moulton, chief executive of Fitzrovia International, points out, one type of cash fund should be much the same as the next.

Explaining why some groups offer cash funds with total expense ratios between 0.5 and 0.6 per cent, while others charge more than 1.1 per cent, is therefore an interesting question. With bond funds, total expense ratios range from 0.38 per cent to groups with ratios above 1.6 per cent.

One moral is that that it pays to shop around. There is no point in giving away with one hand much of the benefits gained from taking your money out of the building society in the first place.

Then there are index funds. This hobby horse has already been flogged to death in this column. But you may not have seen that the regular monitoring of tracker versus active funds carried out by HSBC.

It recently showed that the brief triumph of the third quarter last year, when active managers out-performed tracker funds for the first time for some while, was overturned in the last quarter of the year. Only one-third of actively-managed funds beat the index in 1998 and inthe past 10 years only one in five has managed the feat.

Fitzrovia's analysis confirms that index funds are also the cheapest way to invest in the equity market. The figures are given in my second table.

UK tracker funds have total expense ratios a third to a half cheaper than those of actively managed funds. Index funds remain the benchmark against which other types of managed fund must be measured. Boring - but true.