Can we afford financial services in times of austerity?



Thomas Philippon , the celebrated economist, gave a lecture on Tuesday Morning as part of London University’s Leading Minds series.

The gist of his talk is that the cost of financial services (the collective name for everyone who is an intermediary between the gross return and what we get – is 2%pa.

What is more, it has remained roughly 2% pa since the late 19th century (before which there is no adequate data). There have been times when it has been less (during the second war) and there have been times when it has been higher but 2% pa seems to be the cost of financial services to which things revert.

Yesterday I met with Daniel Godfrey who is chief executive officer of the Investment Management Association. We had a discussion about the costs of fund management (including the variable stuff you don’t see as it impacts the return on your money without being declared).

Daniel made the point that declaring the variable stuff was dangerous as past costs should not be relied upon as indicative of future costs. The same point was made by fund managers and consultants at an NAPF meeting held last night to discuss value for money.


Some things never seem to change

I pointed out to Daniel , that Thomas Philippon’s work suggests that whatever else varies (stock market returns, inflation, bond yields) , one thing is certain, the financial services industry will always be paid.

What I didn’t point out was that the current growth projections for a taxed fund (permitted by the FCA are around 4%. So that 2% pa represents about half what someone is expected to make from an investment.


Should we be surprised?

Philippon expressed surprise at his findings. He had firstly assumed that Adam Smith was right and that specialisation would lead to greater efficiency.

Another economics professor, John Kay , has pointed out that a typical financial transaction passes through the hands of 13 intermediaries between execution and the point where someone can take his or her money.

Phiippon concluded that in the matter of financial services, Adam Smith appeared to be wrong, intermediation did not lead to greater efficiency, it just led to more intermediaries.

Philippon was also surprised that despite the recent (in terms of his study) arrival of the computer, the costs of financial services had not fallen. One voice from the floor suggested that the technology dividend appeared to have been paid to only one class of stakeholder- the intermediary.

All this may not seem very new. In 2012 John Kay wrote

the stockmarket exists to provide companies with equity capital and to give savers a stake in economic growth. Over time that simple truth has been forgotten.

As the title of Philippon’s lecture was “rebalancing the unequal financial service system”, I had hoped for some news of progress. Perhaps the financial services industry had woken up and were likely to give up some of the 50% of the economic growth that they are currently taken.

Edward Bonham Carter, who runs the fund manager Jupiter, made the point that a large part of Britain’s economic growth was down to financial services, which sort of answered the question parochially, though I doubt that thought was of much comfort to the 58m who don’t participate in our financial services industry.

For the 2m who do, the IMA and the NAPF and our other august institutions are doing a great job, ensuring that the financial services system remains unbalanced.


Should we tell the staff?

As Roger Mattingly, speaking at the NAPF’s event pointed out, opening up debate on value for money to members of pension schemes could lead to them asking all kinds of awkward questions, to which we would have no answer.

I think he is right, as I went home from last night’s event, I reflected on the various meetings of the past two days and asked myself whether we can continue to afford to pay financial services so much of our economic growth. Just the kind of question I suspect Roger worried about me asking.

The sharp witted of you will recognise that the keyboard on which I write was paid for from the funds of pensioners and that I am complicit in this, I bite hands that feed me.

And this is the point. As Daniel points out, the IMA and NAPF are member led organisations. They sit at the top table and inform the FCA and tPR on policy matters.

The FCA and tPR are however tax-payer (consumer) led organisations. Yesterday, the FCA published the final rules for the governance of independent governance committees. On the same day laid the draft regulations for better workplace pensions .



What these documents have in common is a recognition by Government that the free for all that the unequal financial services system must change by force of law.

In ridding us of active member discounts, imposing a charge cap and requiring trustees and insurance companies to put the consumer first in considering value for money, the Government are intervening in a very radical way.

One Trustee, sitting next to me at the NAPF meeting made a good point.

“Good governance is a state of mind”.

“Financial Services” will only be able to understand these regulations if they change their mind

By the end of next parliament, I expect that people will be able to see the past costs of the funds into which they invested and draw their own conclusions. I suspect that as they do with past performance, they will compare and contrast.

Consumers, and those who act for them (fiduciaries) have to be able to understand what they pay for financial services. Government need to make this happen.

If they do not, there will be no pressure to bring costs down, that 2% pa will just keep rolling along, the rich will get richer , the poor get poorer- everybody knows.




About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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3 Responses to Can we afford financial services in times of austerity?

  1. says:

    A good article. However, what is the solution? Ongoing annual management charges for fund managers will be pressurised now that they are explicitly stated, as will any platform charges, as will ongoing adviser charges. But the thing is most industries, products and services have high ongoing costs. Why should financial services be any different? With a computer you have to pay electricity to use it, pay for a room to sit in to use it, a chair to sit on, a screen cleaner, annual anti virus software, service warranty, software updates and programmes/applications etc. And then you have to buy another one. With a car you have to pay for replacement tyres, brake pads, air filters, petrol to run it, annual service costs, MOT. And then you have to buy another one. Every time you buy a new car or a new computer the customer does not get told how much money the show/car showroom company charged/ how much the car salesman earned/ how much mark-up the computer or car manufacturer charged the retailer. Things cost money, that’s the way of the world. The one cost that is specific to financial services and which has increased exponentially is that of regulation. The FSA and its various manifestations have created a world of rules, regulations and guidelines which place onerous costs in terms of time, administration, stationery, supervision, reporting, accounting and retrospective justification. I totally understand why regulation was and remains necessary, but cannot agree with what it looks like now. The current regulatory framework has focussed on the wrong things at times, and has missed out on preventing the big picture travesties of LIBOR rigging, Interest rate swaps to commercial borrowers, excessive lending and shadow markets for debt financing. Finally regulators have started to address the design of products and the behaviour of banks and product designers, but for too long they have focussed their resources on the adviser selling them. If you make bad cars or bad products it doesn’t really matter how good the advice is. The need to develop fairly priced, non front-loaded products has been recognised with RDR, although RDR has sadly misfired in delivering on the most important of its aims, that of giving access to advice. The general truth is that long term deposit investments do not protect against inflation. Risk based assets are the only way to beat inflation in a meaningful way long term, that seems incontrovertible. The vast majority of people do not understand risk and do not know how to manage it. Therefore financial services exists as an industry to help close those gaps. It needs paying for doing so. There will be times when the client pays 2% to get a negative return and times when they pay 2% to get a 50% return. It’s swings and roundabouts. Better to invest £500 per month and get a net return of 2% than keep £500 per month in a deposit account earning 0.3%. Reducing the cost of regulation will help reduce the charges of fund managers, advisers and product providers, all of which can then reduce the 2% charge. But there is a floor for receiving advice, and if the client chooses to they can avoid advice and can avoid platform charges. But if they want access to expertise they need to pay for it.

  2. RS says:

    Dear Henry Tapper,

    Thank you for this article and others which you publish.

    I think a number of factors have led to the persistent 2% intermediary charge in the financial services sector – a lack of real competition due to obfuscation on costs (as you have highlighted), distorted incentives, a product which sells future returns which can’t be known (and therefore makes it difficult to price the service) and too many layers between the actual provider of risk capital (savers) and the provider (many mouths to feed!).

    The end result is a tragedy for the public at large. The industry has not performed.

    Trustees must act in the interest of savers – career risk, herd behaviour need to be addressed. Like you said value for money must be a key consideration – if a fund has increased its AUM but its running costs have remained the same % the relevant question must be what has happened economies of scale? If the expectation of better returns by paying more has not materialised it should be fully investigated.

    Keep up your good work!



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