Examining the advent of full collective investment schemes cost disclosure.
With increasing legislation in the financial services industry and a move towards a Treating Customers Fairly (TCF) outcomes-based corporate culture, we have seen a number of changes in disclosures and practises – perhaps most importantly in what investors pay for investment management services. Of particular interest are the transaction costs (TC’s) and total investment charges (TIC’s) disclosure requirements for collective investment schemes.
This is particularly relevant to two of the six intended outcomes of the TCF guidelines:
- “Customers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture”; and
- “Customers are provided with clear information and are kept appropriately informed before, after and during the point of sale”.
The introduction of this new fee calculation methodology at the beginning of 2016 has forced collective investment schemes to reveal the true cost of investment management services.
Typically, on a minimum disclosure document (MDD), a Total Expense Ratio (TER) would be disclosed, which generally only includes the management fee and any applicable performance fees. However, with this year’s additional MDD disclosure requirements, transaction costs must also be disclosed. This includes a number of other charges which can materially impact the net return an investor would achieve. Both TER’s and TC’s must be prominently disclosed in any marketing material or subsequent investor communications.
Officially, “TC is a measure that can be used by investors and advisors to determine the costs incurred in buying and selling the underlying assets of a Financial Product” (Source: ASISA). These include the following:
- Securities transfer tax (“STT”);
- Investor protection levy;
- STRATE contract fees;
- FX spread costs;
- Bond spread costs and
- Certificates for Difference (“CFD”) costs.
Both TER’s are TC’s are measured as a percentage of Net Asset Value (NAV) over three-year rolling periods, if applicable, or over any available history since the inception date for a fund with less than a three year operating period.
As at June 2016 TC’s have the following tabulated effect on a group of large local general equity funds:
Source: NFB Asset Management
The additional cost, of which many retail investors may well have been previously unaware, ranges from 2.62% to as high as 53.85%, with an average of 19% which is significant. It should be noted that these costs were always active within unit trust funds, the only difference is that they must now be disclosed.
The major factors which would contribute to a high TC would include high portfolio turnover or expensive trading costs (frequent and/or high brokerage costs and higher STT as a result of more frequent trading); illiquid assets (bond spread costs); illiquid currencies (FX spread costs) and leveraged positions attracting high funding costs (CFD’s). The investor protection levy and STRATE levies are of such a small nature, 0.0002% and 0.005787% on the value of a trade respectively, that these two costs will not make a material impact to the TC of comparable funds.
The following inferences can be made from the above table.
- Fund 1 has the highest TC of the group indicating higher turnover of securities, itself indicating a more active approach to generating alpha which probably makes this manager a momentum manager.
- Fund 2 is a value biased portfolio.
- Fund 6 which has a total fee of 0.6%, 0.21% of which are trading costs, is most likely to be a passive index fund for two reasons – the low fee in comparison to its competitors indicates a lack of active management; the high TC would be the effect of a need to rebalance to index weights at fairly regular intervals in order to minimize the tracking error in the portfolio.
- Inferences on the basic TER differences can only be reasonably done with a full understanding of any applicable performance fees.
It is important to be cognisant of the true cost of investing by ensuring you are kept fully informed with fees structures and the legislative requirements your investment manager is subject to. This is just one of the instances where a trusted and qualified financial advisor adds long term value to your portfolio by engaging with and using their scale of assets to negotiate preferential pricing arrangements with fund managers, where DIY retail investors would not necessarily have access to such benefits.