Investments  

Hidden fees ‘like Loch Ness Monster’

What do the Loch Ness monster and hidden fund fees have in common? Here is a clue: the existence of the legendary creature is yet to be validated by concrete evidence.

Similarly, accusations that funds contain hidden fees are simply heresy, the Investment Association suggests in its latest report, in partnership with fund research firm Fitz Partners.

Or in the words of the trade body, which is bankrolled by fund managers: “The report finds zero evidence that funds’ returns are affected by hidden fees lurking within.” It suggests that “hidden fund fees” may in reality be the “Loch Ness Monster of investments”.

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The IA validates its assertions with the headline findings of the study, which analysed the performance of 1,350 active and passive funds between July 2012 and May 2015.

The body opted to focus solely on bundled share classes for, it said, consistency given the timing of the introduction of the Retail Distribution Review and the subsequent unbundling of platform and adviser charges.

Entry and exit charges were omitted from the study because their effect on the overall outcome is minimal and they do not reflect what is happening on an ongoing basis, according to the IA.

So too were performance fees, which can be recurring, but were out of scope because they incur only when the fund outperforms a specified benchmark, it added.

The IA found on an asset-weighted basis, transaction costs across the IA equity sectors in the 34-month period were 0.17 per cent – the result of the average portfolio turnover rate of about 40 per cent.

Its research also shows that it was more expensive to trade in some sectors, such as China, than in very liquid markets such as North America. What is more, active UK All Companies funds had an average transaction costs of 0.19 per cent compared to 0.05 per cent for tracker funds.

“This clearly contradicts claims often made that trading costs amount to several multiples of fund fees, as can also be seen from the comparison with average ongoing charges (OCF) which across all equity sectors are on average 142 bps and for UK All Companies specifically slightly lower at 122 bps,” the report stated.

The IA hypothesised that if there were ‘hidden costs’ it would expect the average fund return to fall short of the benchmark return – which averaged to 12.50 per cent – by much more than 1.59 per cent – the sum of the transaction costs and the OCF.

However, contrary to this expectation, funds covered both ongoing and explicit transaction costs and delivered returns averaging to 0.71 per cent higher than that of the benchmark, the research found.

It should be noted that between 2014 and 2015 funds underperformed the benchmark, but only by 0.37 per cent – far less than the expected shortfall of 1.56 per cent.

The report said: “Post-RDR it should be possible to measure much more clearly fund manager delivery which will help to inform the value for money debate and the results would be even better using the new unbundled pricing of the ‘new’ primary share classes.”