Thursday saw the Monevator inbox swell up like a Spanish housing bubble. Email after email came in from dedicated readers horrified by the price bomb dropped on their heads by Interactive Investor (the discount broker commonly known as iii).

In one fell swoop, iii swung from being one of the cheapest execution-only brokers around into being about as suitable for small passive investors as mood-altering dance music concealing subliminal BUY / SELL messages.

Let’s quickly recap on what iii has done and why, look at how bad that actually is, and then you can consider some F U iii responses here.

What has iii done?

The investor anguish is palpable, not far off Charlton Heston’s fist-pounding “God damn you all to hell” moment in Planet of the Apes. From 1 July, iii is introducing the following price changes:

£20 quarterly fee

• This is an £80 per year flat-rate charge for holding an ISA or trading account.

• Only one fee is paid per customer even if you have multiple ISA and trading accounts.

• Family members can link their accounts so that one fee covers the lot.

• New customers won’t pay this fee if they invest using the regular monthly scheme and have contributed less than £5,000.1

•  iii is reportedly refusing to apply this waiver to customers who joined before May 30 2012.

£10 trading fee for all funds

• Or £1.50 per fund purchase through the regular monthly investment scheme.

• Trading fees are deducted from your £20 quarterly fee. i.e. You get two £10 trades for free per quarter.

100% trail commission rebates

• …but this makes little difference to passive investors who have already chosen low TER funds that pay next to nothing in trail commission.

• You’ll need about £80K in your portfolio for rebates to outweigh the new quarterly fees if you use the kind of index funds recommended in our passive Slow and Steady portfolio.

Previously, iii did not charge a quarterly fee and you could trade funds for free.

Ah, the good old days.

How bad is it?

Frankly, it’s pretty grim. Flat-rate charges always hit small investors hardest. Here’s how much you’ll lose from your return if you pay £80 in extra management charges per year:

The UK stock market has historically offered a real return of 5% per year. A loss of 1% in fees would rob you of 20% of that gain.

That’s why fees matter, even if the percentage cost seems trivial. The loss is potentially huge for current iii customers who are struggling to build up their investments, and there are plenty of Monevator readers in that boat.

If you hold a Slow & Steady style portfolio then you’ll dilute the above costs by around 0.13% a year, thanks to trail commission rebates.2

Then we get to the impact of trading fees

The Slow & Steady portfolio holds a diversified suite of seven index funds that could previously be traded for free with iii.

Contributing to each fund every quarter would cost an additional £50, according to iii’s new pricing plan.

That’s £200 per year – without even thinking about rebalancing sell trades.

If we switched to iii’s monthly investment scheme, we would make £10.50 worth of purchases every month. That would mean paying out £11.50 every quarter on top of the management fee, or an extra £34.50 per year (again without rebalancing).

It’s all far too much to give away. I wouldn’t now give iii a second look unless I had a portfolio worth over £32,000. Even then, there are plenty of better alternatives available.

Infuriatingly, iii has given customers just a month to react to these sweeping changes. I’m sure that fulfills the requirements of its terms and conditions, but it hardly smacks of a firm that cares for its customers. And neither does the disingenuous justification that coats iii’s explanatory email like a layer of slime.

You can read the letter and enjoy it being taken apart by one outraged customer at the Simple Living In Suffolk blog.

We all know that brokers love churn but iii’s claim that its move is in the interests of investors, who it ‘believes’ should ‘actively manage’ their portfolios, feels to me about as sincere as Peter Mandelson thanking his aunt for a Christmas present of Argyle socks.

Why is this happening?

It seems likely that charging higher fees is less to do with an ingenious attempt to help customers ‘engage’ than it is connected to the Retail Distribution Review (RDR).

The RDR is the FSA’s regulatory tsunami that’s been rumbling towards the financial services sector for a couple of years. It finally hits on 1 January, 2013.

A major part of the RDR brief is that product costs should be transparent to investors. That means financial advisors will no longer be able to collect trail commission paid for by investors through fund TERs that see us skip home thinking we somehow got the nice man’s advice for free.

Critically, the FSA has not yet decided whether to ban the trousering of trail commission by execution-only platforms like discount brokers and fund supermarkets. That decision is due before the end of 2012.

Currently, execution-only platforms hoover up trail commission from funds, even though they dispense no advice. That enables the platform to turn a profit while leaving us in a blissful state of ignorance about the true cost of its services.

Brokers like iii and Hargreaves Lansdown appear to have decided it’s game over for trail commission and we might as well all get used to it.

Sadly while this financial glasnost makes a lot of sense, it bizarrely works against passive investors who know how to take on the system.

We aren’t about to get a windfall from active funds full of trail commission fat. Instead, we’re getting stung by the disinfectant of financial reform – just as somebody who’s inoculated themselves against bank overdrafts and loans will when free banking finally comes to an end.

Still, there are plenty of other platforms that are keeping their powder dry, or reshuffling their fees in a more passive investor-friendly way than iii. Take a look at your options here.

Take it steady,

The Accumulator

1. The fee waiver comes with other conditions attached as outlined towards the bottom of this page. [↩]
2. Assuming you hold around 10% in the L&G Global Emerging Markets index fund. That fund offers trail commission of around 0.4% while the other funds come in around 0.1%. [↩]

Plus some good reads from around the web.

Given the competing attractions of street parties in the rain and watching News 24 to spot Prince Philip putting his foot in it, I doubt many will see this edition of Weekend Reading.

Although you are here. Thank you! I won’t overstay my welcome.

Here’s my bit for the Jubilee – a bunch of statistics about investing over the Queen’s 60-year reign, followed by the usual roundup of links.

The UK stock market’s glorious 60-year run

• £1,000 put into the UK stock market six decades ago would now be worth in excess of £1 million, assuming all dividends were reinvested.

• That’s equivalent to a compound return of 12% a year.

• £1,000 of gold bought in 1952 would now be worth £81,360.

• Shares were cheap in 1952. Glaxo Laboratories (the forerunner to GlaxoSmithKline) was on a P/E of 2! Low valuations do wonders for future returns.

• British Motor Corporation, formed in 1952 by the merger of Austin and Morris, controlled 50% of the UK car market, and was valued at £35 million.

Source: Telegraph and The Motley Fool (see links below).

Savers victorious

• Savings now stand at an average of over £150,000 per household, including pensions, investments and deposit savings, compared with just below £50,000 in 1951 (at today’s prices).

• Wealth in the UK wasn’t evenly spread then or now. In 2011, almost one in three UK households had no savings, while a further fifth had less than £1,500.

• Household savings recorded their biggest rise in value in the 1980s, with a real increase of 115%.

• Savings fell 12% in the 1970s in real terms due to ruinously high inflation.

• Deposit savings’ share of total savings has fallen from 42% to 29% since 1951. Pensions and life insurance’s share has more than doubled from 24% to 53%.

• The gross interest rate offered on no notice accounts has averaged 6.01% over the past 60 years. But in real terms, savings rates averaged 0.29%.

• 1950s ‘Savers’ clubs’ were popular ways to save for Christmas and holidays, even though they paid no interest!

House prices since 1951: We are not amused

• House prices across the UK have nearly trebled over the past 60 years, up by an average of 186% in real terms.

• Prices have risen at an average annual real rate of 1.8%, slightly faster than the 1.6% per annum average rise in real earnings.

• In nominal terms the average UK house price has increased 7,278%, from £2,200 in 1951 to £162,338 in 2011.

• London has seen a real rise of 189% in just the past 40 years.

• House prices recorded their biggest increase in the 1980s, with a real rise of 42% between 1981 and 1991. That’s greater than the increase of 30% during the last ten years.

• The worst performing decade was the 1950s. House prices declined by 7% in real terms.

• House prices have been the highest in relation to people’s earnings over the last ten years. Prices averaged 4.8 as a multiple of gross annual average earnings between 2001 and 2011, peaking at the highest level in the past 60 years at 5.8 in 2007.

• This compares with the average ratio of 3.9 since 1951.

• Property values were lowest in relation to earnings in the 1990s, when the average house price to earnings ratio was 3.4.

• The number of houses built each year has fallen by one-third since 1951.

• In 1947, more than four in ten households lacked a fixed bath or shower. By 1991, this proportion had fallen to just three in a thousand.

• Nearly two in three households (64%) were without a basic hot water supply in 1947. By 1991, this proportion had fallen to one in a hundred.

• Home ownership has more than doubled over the past 60 years, from 32% of all households in England in 1953 to 66% in 2010-11.

Source: Halifax / Lloyds TSB press release.

[continue reading…]

Poor Warren Buffett. The company he runs, Berkshire Hathaway, has over $37 billion sitting around in cash. But with a near-$200 billion market capitalisation, Buffett has to buy on a monumental scale to move the dial.

If Buffett could chuck me a billion or two, I think I could make him some money. That’s because various shares listed on the UK stock market are currently trading at a big discount to net asset value (NAV).

They might boast £100 million of assets after debt, for example, yet only be trading on a valuation of £70 million.

On the face of it, you’re being offered the chance to buy £1 coins for 70p. With a Buffett-sized warchest you could buy these companies outright, wind them up, and pocket the difference!

Well, it’s a nice theory. In reality there are costs involved with realising assets – perhaps as much as 5% of the NAV – and it can take a while, too. And when investing, time means money.

Also, if anyone got wind of Buffett or another deep-pocketed investor buying up such shares in a big way, the price would shoot up. Shareholdings above a certain size have to be declared, so there’s a limit to how sneaky you can be.

Finally, there are the takeover rules. Buy too many shares and you’re going to have to make a formal bid for the company. Again, that’s going to drive the price higher – perhaps too high to make your wind-up plan worth the bother.

You win if you’re right – but when?

So much for why Mr. Buffett isn’t shopping in London for bargains. You and I have different problems. We can put a few thousands pounds into an investment trust trading at a discount without so much as rippling the price.

Rather, that’s where our problems begin.

You might decide an investment trust or company deserves to trade closer to the underlying NAV of its holdings, but who’s listening? If Buffett bought in it would make headline news. When you buy in, nobody cares except your broker who enjoys the dealing fees, the taxman who gets his 0.5% stamp duty, and your partner who wonders where that £5,000 they’d earmarked for a new car went.

As a small investor buying into an ‘asset play’ like this, all you can do is plan for one of three outcomes:

• You win – You correctly identify an investment trust or similar company trading at an unwarranted discount to its NAV. Perhaps better results attract more attention, or perhaps an activist fund takes a stake and starts demanding the board make changes or even liquidates all its holdings and returns the cash to shareholders. Either way, the NAV stays firm or even increases while the discount gets smaller as the share price rises. On paper, you’re in profit.

• You lose – Perhaps the discount was warranted, after all. The market was right to be skeptical of the value of the property or investments or other assets that comprised the company’s NAV. Rather than the share price rising, the discount is closed as the NAV is written down. The share price likely falls, too,1 and you potentially make a loss.

• You wait – Often nothing happens. You keep holding the shares, maybe collecting a dividend for your troubles, while watching events unfold. You take a holiday. One of your children starts school. Sooner or later one of the above two scenarios happens, but you could be waiting years.

There is no easy money on offer in the stock market, and buying assets at a discount is no exception.

Asset plays aren’t easy money

If you pay 70p for assets worth £1 then something good is likely to happen, but there are no guarantees.

That said, I would wager that the ordinary person is likely to fair better with asset plays than, say, trying to outthink the analysts when it comes to the share price of Rolls Royce or Vodafone.

That’s because investment trusts clearly move in and out of favour, and fear and greed is easier to spot in the discount to NAV compared to a potential boost to Vodafone’s earnings that went unnoticed by dozens of professional analysts covering the stock, for example.

On the other hand, it’s mentally difficult buying into something other investors are clearly avoiding. For good reason, us human beings have evolved to do what other people do. Those who charged on regardless tended to run off cliffs, got eaten by lions, or poisoned themselves by feasting on rotting food.

Is the opportunity you’ve spotted a gold mine or a mineshaft? Only you can make that decision if you go down this road, and you must live with the consequences.

Such is the lot of an active investor.

1. Note that the share price might not fall. For example, a new CEO could come in and order a revaluation of assets that restores confidence in the NAV, but at a lower level than before. It might still be higher than the price you paid for the shares, however. [↩]