Mirror Funds Explained (23/3/2006)
 

All the financial institutions that Candour Consultancy (and our competitors) recommends are competing for the same business. Virtually all these financial institutions are based in the UK offshore islands, operate under the same regulation, employ the same demographic of staff, have offices of roughly the same sizes and pay advisers the same introduces fees; i.e. their overheads are roughly the same.

So when you are shopping around for the best offshore savings plan, pension or investment, why are there such huge discrepancies in the published charges and the illustrations of potential returns? Why would institutions such as Generali and Aviva charge you substantially more than, let’s say, Friends Provident or Royal Skandia and consequently make themselves completely uncompetitive?

The answer is they do not. The total cost of all the policies is almost identical to those of all their competitors; the difference is how transparent the companies are with these costs.

Whereas companies such as Aviva, Generali International, and Scottish Life International provide direct access to the funds you choose and place all the charges in the wrapper; virtually all their competitors use ‘Mirror Funds’ which more often than not contain additional expenses.

A mirror fund invests exclusively in the underlying fund (i.e. the Invesco UK Equity Fund) but, rather than investing your capital directly into the fund as Aviva, Generali and Scottish Life do, the financial institution creates a fully licensed and regulated mirror version of the fund. As well as the additional administration costs of running a mirror version of a fund, the fund has to meet financial regulation in its own right and therefore also incurs compliance expenses. Where the mirror fund is managed by an external fund manager, there may also be an additional annual management charge levied by the fund managers to cover their fees similar to the charges in a ‘fund of funds’ product.

The mirror fund may also hold a proportion of its value in cash to aid liquidity; which is an important function of fund administration. This often results in the performance of the mirror fund differing from the performance of the underlying fund as the cash element in the mirror fund places a drag on the growth of the fund.

The effect of the additional administrative charge on the fund and the cash element is that, whilst the performance of the mirror fund price will rise and fall broadly in line with the performance of the underlying fund, the returns will be lower than those obtained via direct investment.

To show you the effects of this we have chosen some funds offered by Generali (who offer direct investment) and compared these to funds offered by one of their competitors who offer mirror funds:

*  All values from performance literature provided by Generali & Friends Provident; March 2006

** All performance figures are based on the US Dollar version of the funds

What the above data shows is that, over just a 3 year period, the performance of a portfolio of these mirror funds would be nearly 12% less than a portfolio that is directly invested in the exact same underlying funds - this is across a broad portfolio of fund managers and markets. Just imagine what the effective reduction in yield would be over 25 years to someone saving towards their retirement or looking to repay a mortgage!

Consequently, Candour Consultancy primarily uses financial institutions that place all their charges in the wrapper as we feel this makes the whole product more transparent. We realise that these products do not look as attractive upfront and it involves substantially more knowledge and understanding on our part to explain our recommendation to potential clients; however, we strongly believe this is fairer on the policyholder and in the long-term better for all involved.

That said, we recognise that there are times (for example when a financial institution offers a very good special offer) when the enhanced terms outweigh the cost of the mirror funds.  At Candour Consultancy, we constantly monitor what products and terms are available and, as and when enhanced terms provide a more attractive option, we too will then recommend the applicable product.