RICHARD DYSON: Fund advice tainted by commission

By RICHARD DYSON, MAIL ON SUNDAY DEPUTY PERSONAL FINANCE EDITOR
Updated: 20:20 EST, 3 April 2010

Would you follow the investment recommendations of someone who is paid purely on commission? Most people would prefer not to, but in the distorted world of investment marketing, commission is very difficult to avoid.

With tomorrow the last day of the tax year, investment companies have all but finished the annual marketing spree that sees them trying to capture the biggest slice of the private investors' yearly Isa allowance.

It has been an excellent Isa season for several reasons. First, over-50s have been allowed a higher allowance of £10,200.

It is predicted that this will be the best Isa season since 2002 but the biggest beneficiaries will be the increasingly powerful fund brokers

Second, paltry interest rates have encouraged otherwise cautious investors to push more of their money into bond funds or equity income funds.

Third, the stock market's 50 per cent rally over the past year has whetted an appetite for risk.

Sales of investment funds to private savers during February were the highest ever for that month. It is predicted that this will be the best Isa season since 2002.

Among the biggest beneficiaries of this will be the increasingly powerful fund brokers that in the past decade have sewn up the market in selling big-name investment funds to small savers.

The most astonishingly successful of these businesses is Hargreaves Lansdown, which with 400,000 users (I cannot quite call them customers - I will explain why later) has achieved an almost terrifying grip on the industry.

If a company wants to launch a new fund, the first thing it does is send a representative to Hargreaves to ask whether it will handle the promotion.

The reason is simple: if Hargreaves promotes a fund through its cleverly targeted mailshots and other measures, it can raise £100million or more. Hargreaves can make or break a fund launch.

As far as its 400,000 users are concerned, Hargreaves provides a good service. It publishes a list of 150 recommended funds called the Wealth 150, which many users are only too pleased to follow, as it saves them doing their own research. Hargreaves is efficient. And crucially it is also often the cheapest way to buy funds.

But I question Hargreaves and its other, less successful rivals because these firms remain dependent on commission.

Hargreaves is not paid by its 400,000 private users. It is the fund companies - the firms whose products Hargreaves promotes and sells - that write the cheques. And that process is opaque.

Take Invesco Perpetual, a fund firm whose investments Hargreaves has promoted for years. How much commission does Invesco pay Hargreaves? No one knows, but I would hazard a guess at £30million to £50million a year. Jupiter and Fidelity probably pay something similar.

Last year, Peter Hargreaves, the man who co-founded the firm and who is at number 176 in the Rich List with an estimated personal fortune of £310 million, published a book called In For A Penny: A Business Adventure. In it he describes the 'revolutionary' moment when he decided against accepting upfront commission for selling investments.

But it wasn't a real revolution because the model he stuck with was one where he would continue to receive annual commission - typically 0.5 per cent - for perpetuity.

To this day commission remains the petrol in the engine. The people paying Hargreaves - I would call them the real customers - remain the Invescos and Jupiters and so on.

A real revolution will come only when big sellers such as Hargreaves Lansdown break free of commissions and instead charge private investors an equivalent fee for managing their accounts.

At that point these firms will cease to be the distribution arm of the fund industry. And only then will they be able to look their private investor clients in the eye and genuinely claim to operate in their best interests.

Only at that point will the critics who claim that lists of fund recommendations are biased by commission be silenced.

And only then would Hargreaves be able to demand good performance from a fund company without being compromised by taking a pay cheque on the way out.

Fund companies like commission because it is a useful way of distributing often mediocre investments. And it enables salesmen to purport to offer services to private investors for free.

There needs to be change.