Every time Mrs Smith walks into her adviser’s office to top up her ISA, a whole chain of reaction is set in motion and the number of ‘entities’ getting paid in the process should make your blood boil.
It is estimated that there are, at least, 11 to 14 service points between a retail client and the stock market. No one really knows the full extent of the hidden costs in the fund industry, but if we did, there would be a public outcry. Every investor in the country; every one saving in pensions and ISAs would be on the picket line carrying placards chanting ‘get your straws off our smoothie’
So let’s have a go at naming these ‘entities’ between the retail client and the market – Adviser, Platform, DFM, Fund Manager, ACD, Depositary, Custodian, Broker (research), Broker (dealer), CREST, FX dealer, HMRC, Securities lending counterparty. Oh and the FCA! The list in just mind-boggling!
Advisers are of course the most valuable part of the chain. Their cost is known and in spite of the scaremongering pre RDR, most clients continue to value and pay for advice. And those choose not to are able to make (hopefully) informed decision about the costs vs. benefits. But while advisers and now platform are required to be completely transparent about their fees, asset managers continue to enjoy the luxury of helping themselves to as much of clients’ money as they want, without full disclosure and transparency.
Here’s the only thing you need to know about Total Expense Ratio; it’s not the ‘total’ of anything really.
The best way to think about fund expenses is to imagine an iceberg – the seen part pales into insignificance in comparison with the hidden part. This unseen part of the iceberg consists of transaction/dealing costs, profits from securities lending, FX spreads and interest retained by managers on cash balances. So, exactly how much is the hidden costs? Pluck a number out of thin air and you won’t be off the mark, because frankly, no one really knows.
While I spend a great deal of time obsessing about this stuff, it’s beyond me. The tiny bit even I know on the subject, I learn from the work of people like Dr. Chris Sier, who has done a great deal of research on the subject. The problem is, even Dr. Sier could only speculate on what the exact cost might be. He estimates that the ‘real TCO (Total Cost of Ownership) approaches 3% per annum’ for pension funds! I’ll imagine that retail funds are probably similar, may be even more. So next time you see OCF of 90bps on your fund factsheet, rest assured, you are being lied to.
There’s been a lot of rhetoric about transparency in the fund industry lately. The government wants to cap pension charges. Nonsense! How can you cap something you don’t know? Then last week, the Government announced it plans to force DC schemes to disclose all charges. That clearly doesn’t go far enough. This needs to extend to wider retail funds and pretty quickly.
The IMA – Investors Mismanagement Association (hey, don’t shoot me down, that’s borrowed from Gina Miller of True and Fair Campaign) is dancing around the edges on the matter. Its draft Statement of Recommended Practice (SORP) proposes that fund managers should declare some transaction costs (mainly trading and research commission) but portfolio-dealing spread is optional. And it doesn’t suggest publication of profits made from securities lending; interest creamed off cash balances, transaction costs incurred by underlying funds (where held) and portfolio turnover rates.
It’s been suggested that MIFID II will fix the lack of transparency in the fund industry when it becomes law in 2016 but the IMA says that this doesn’t apply to UK funds.
I read recently that, in a move to make their fees more transparent, one major fund manager has changed its charging structure to include ‘all-in cost excluding transaction costs.’ That’s an oxymoron, isn’t? It’s not ‘all-in’ if it doesn’t include transaction costs!
And off course there are those who would say ‘trading costs are reflected in the performance and disclosing them doesn’t really change anything’ Really? It’ll stop fund managers over-trading for starters. Not to mention improved competition, which will drive down the overall cost of investing. In any case, it’s a matter of principle. I don’t know many things we buy without knowing the full cost.
What the role of advisers? I read this good article on AdviserLounge that advisers need to move on from RDR and be part of the big conversations in the wider financial sector. Personally, I think this is where the big conversation is right now. Advisers, as agents of the client, need to be more demanding of asset managers.
Fund selection should include due-diligence that asks managers difficult questions about practices around transparency of costs. And how much attention do you pay to portfolio turnover rate? What proportion of stock-lending fees is kept back by managers? What’s the cash drag on the fund? If they won’t tell you, they probably have something to hide.
I also believe that advisers who are able to find ways to reduce cost by avoiding some of these hidden charges are adding more value to clients than those who aren’t.
The good news is, the iceberg is melting. Days of opacity in the fund charges are numbered as regulatory pressure forces on managers what any other self-respecting industry would consider normal business practices. In the meantime, fund managers continue taking us for a mug – you, me, your clients, the Government – everybody! They are peeing in their pants laughing at us all, for now.