Broker funds run for benefit of managers, not clients

The financial regulator has uncovered a record of years of dire performance by various broker funds, writes Andrew Verity

INVESTORS WHO allow independent financial advisers to manage up to pounds 1bn of their savings in so-called broker funds are suffering very poor investment performance, City regulators warned this week. Around 100,000 people invest in broker funds, run by independent financial advisers rather than life insurers or investment managers.

In the past, advisors have argued that their detailed knowledge of clients, and the ability to tailor an investment fund to meet their specific needs, offered the potential for outperformance when compared to funds managed by large investment management houses.

However, in its first published survey on the issue, the Personal Investment Authority (PIA) has found damning evidence of bad value for money in the funds. On average, they returned over 50 per cent less than funds run by dedicated managers.

David Peffer, chief executive of the PIA, says: "Existing investors should watch performance carefully and ask themselves if they are getting value for the extra charges."

Mr Peffer's comments follow mounting concerns about this neglected investment area. Financial advisers typically levy their own fee on top of that normally charged by the life insurer, doubling the level of charges. Total charges usually run to about 2.5 or even 3 per cent a year. This means that, assuming inflation of 2.5 per cent, a fund needs to grow by up to 6 per cent for its value just to stand still.

The PIA's survey reveals that savings invested in broker funds returned an average of 2.5 per cent a year over the last five years - compared to 4.6 per cent for dedicated fund managers. Investors who put their pension money in broker funds also fared poorly. Broker funds returned an average of 4 per cent a year, against 6.2 per cent for dedicated managers.

The PIA has launched a renewed crack-down on the funds. Advisers whose funds underperform will be required to write to clients explaining why their money should remain invested in this way.

The crackdown is the second recent initiative by the PIA after years of complaints that, in many cases, the funds appeared to be run in the interests of independent financial advisers (IFAs), rather than clients.

In early 1997, the PIA insisted brokers running the funds should be properly qualified and began to insist they have the Investment Management Certificate, a formal qualification. Since then, hundreds of funds have been withdrawn from the market. The amount of money invested in the funds has shrunk from pounds 2bn to pounds 1bn, while the number of funds has dropped from 1,300 to 500. The average amount invested is pounds 2m per fund.

Richard Cockroft, policy adviser at the PIA, says: "There is no excuse now for those firms who are managing funds not to have an investment management certificate. The broker fund market is likely to shrink because of two reasons: the qualifications, and the general perception that these are not always advisable - to put it mildly."

The funds also create a conflict of interest for financial advisers which can potentially compromise their independence. If they persuade clients to join the funds, they enjoy a stream of income which is not available when they recommend a cheaper fund run directly by an investment house.

While IFAs charge for "running" broker funds, they rarely pick the individual stocks in which the money is invested. Instead, they simply invest in a selection of funds from those on offer at an investment house or life insurer. Companies providing selections of funds include Capel Cure Sharp, the private client investment manager, and Skandia Life, the Swedish-owned life office. Networks of IFAs, such as Countrywide, also offer funds.

Regulators are careful to stress that the performance figures are only averages - some companies performed better. But performance in particular areas has been dire.

Brokers offering "adventurous" funds for life insurance savings - designed for high risk and high reward - made an average of just 0.8 per cent a year over the last five years, much less than the "cautious" version. Their professionally-run counterparts returned 6 per cent. Broker funds for offshore life savings did particularly badly, on average shrinking by 0.2 per cent a year.