What’s in a name?
The debate of opaque investment terminology goes beyond a simple misinterpretation of terms
The argument put forward for excluding items such as stamp duty and trading costs in a TER calculation is that these are variable fees based on trading the portfolio and therefore difficult to capture on an ongoing basis – a fund may, for example, turn over stocks more frequently one year than the next, resulting in different transaction charges for each period and producing what may be deemed a potentially inaccurate charges figure depending on when an investor actually invests.
There is also the question of over what period you measure these costs. With performance fees, the similar argument goes that there could be a grey area here as if a fund does not generate a performance fee over a particular period the TER would be lower. So which do product providers quote? The underlying cost/TER that will apply regardless of performance fee, or the higher one that only applies when the fund does well?
We also have the question of the fund value used in the calculation - with the FSA definition stating that the calculation should be the ratio of the scheme’s total operating costs to its average net assets calculated as determined by a specified FSA methodology.
Ultimately investors (and advisers) should understand the limitations of TERs, “Ongoing Charges” or whatever calculation is published
One can query whether this methodology is, in fact, providing an accurate charges figure as when a client invests the average value, or net assets, as calculated using the FSA methodology could in theory be significantly different from the actual value at any particular point in time?
In addition there are other potential flaws/anomalies with the current calculation of TER as specified by the FSA such as, as was highlighted in the press a couple of years ago, the fact that where a fund holds ETFs some product providers were not including certain underlying ETFs in their calculation of TER as they argued that these ETFs, in more esoteric areas and mainly US-based, did not have to be included in the TER calculation as they were classified as securities rather than collective investment schemes, which are included in the TER calculation as specified by the FSA.
Finally in a recent paper the IMA further highlighted potential problems with calculating a so-called ‘total cost of investment’ figure explaining that as well as the explicit brokerage and stamp duty costs that make up trading costs, there are bid-offer spreads in underlying stocks.
In addition the IMA highlighted that there is the question of how do you take account of stock lending or how do you measure the cost of derivatives? The IMA also highlighted the challenges surrounding the fact that fund managers operate pricing policies designed to protect continuing investors from trading costs caused by significant inflows or outflows with the result that those costs do not fall on all investors equally.
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