When the FSA wanted to create a clear and simple method of cost disclosure for adviser fees it was hardly a surprise that it chose pounds and pence. While the outcome, objectives and unintended consequences of the retail distribution review are still clarifying, it is hard to argue against the fact that RDR has made the price of advice absolutely clear.
Many will remember the “toing and froing” around the requirement for platforms to unbundle fees/commissions – with the FSA eventually coming down on the side of unbundling. Without clear and discrete charging along the value chain, there is always the risk/opportunity for “fuzzy” disclosure.
Transparency debate
For many years, there has been a transparency debate raging in asset management about cost disclosure, largely driven by passive fund providers and consumer groups. Over time it is fair to say that levels of disclosure have been improving, but surely charges are either transparent or not?
First, we had the annual management charge (AMC), but that did not include many of the raft of different fees that could be charged to a fund. Then we had total expense ratio (TER), which turned out not to be the total – notably missing out the portfolio dealing fees (the buying and selling fees of the underlying securities, stamp duty). Then came the ongoing charges figure (OCF), which represents the ongoing costs to the funds and includes the AMC and other charges for services such as keeping a register of investors, calculating the price of the fund’s units or shares and keeping the fund’s assets safe.
But OCF still excludes fees associated with dealing in the underlying securities – and in the underlying funds in a fund of fund. There have even been some outrageous examples in which managers have treated ETFs as securities and excluded their AMC from the TER figure in a fund of funds.
There is growing evidence, from Morningstar and other studies, that the total costs incurred is one of the few reliable predictors of mutual fund performance. The increasing market share of low-cost index and exchange-traded funds suggests investors are using this information when making investment decisions.
Against this background it is perhaps surprising that the FCA has not acted on this already. In 2014, in Thematic Review 14/7, it said: “Firms must put consumers at the heart of their business model. That means it is important to make comparing costs as easy as possible. As part of the overall relationship between firms and consumers, firms need to manage the costs with as much tenacity as they produce returns, and make the costs they charge clear.”
The Investment Association has recently issued a new consultation on cost disclosure. It noted that: “The asset management industry delivers successfully for millions of customers, in the UK and across the world. It also recognises the need to provide a clearer explanation of the costs associated with delivering investment returns.
“The goal of the code is to develop a consistent and comprehensive framework that will allow fund and asset managers to deliver underlying charges and transaction cost information using standard definitions, regardless of the distribution channel and the way in which this information will eventually be presented to clients.”
They argue that the asset management industry has undertaken initiatives over several years to increase the transparency of fees and costs in what it says remains a fragmented disclosure environment. Surely it is the asset management industry, with all its resource and brain power, that was in the best place to have fixed the issue – it was not that many years ago it denied “hidden fees” (dealing costs) even existed.
Cynics would argue the IA has had plenty of opportunity to take the lead and it is only the arrival of MiFID and recent FCA Asset Management Study that has prompted this action.
Gina Miller, founder of the True and Fair Campaign, said: “It is gratifying that following the IMA’s amateurish 2012 enhanced disclosure of fund charges, the IA has decided to show investors all the costs, but only because MiFID II forces this to happen from 2018 anyway. Its suggested templates are incomprehensible to most investors and fail to meet the MiFID II rules since they still do not aggregate the various costs in one number.”
Many will have sympathy with her view; quite why the IA needs a 63-page document to make charges clear, simple and combined in one number is baffling.
The IA flags that charges are complex and with the wide range of regimes such as MiFID, PRIIP, KID, FCA consultation on workplace pension transaction costs (consultation paper 16/30) and governance committees, the industry needs one simple template for disclosure. Hard to disagree – but perhaps by trying to solve all issues, for all audiences, and all regulators, it can further delay the issue?
Debate has raged for many years about the significance or otherwise of transaction costs. A recent blog by Ben Raven at Tavistock Wealth provides an insight: “One study, which aims to shine light on the 'invisible costs' of active fund management, looks at 1,758 equity funds around the globe. The study concludes that trading costs have a negative impact on performance and are, on average, larger than the expense ratios quoted by the active fund managers. Across the sample the average trading costs were 1.44 per cent per annum. For small-cap funds it was as high as 3.17 per cent a year. To be clear, these trading costs come in addition to the OCF published by active fund managers.”
So, with average trading costs higher than expense ratios, the need for full disclosure of costs should surely be number one on the regulators radar. How can you have transparency over adviser fees without clarity right the way through the value chain?
Not that simple
One issue is that dealing costs will vary year on year, and it is only after the event that full costs are known. It is a bit like buying a car; the actual miles per gallon will depend on how the car is driven, but there are clear flags over which are more economical. It should be easy to flag an estimate of future turnover costs based on the manager’s style and show what they were historically.
Active management is facing a hard enough battle with the lower expense ratios of index funds – surely it needs to lay out its case clearly and openly, or it will face ongoing issues over the lack of alignment with the customer.
Is it hard to work out what the portfolio would have done with no charges at all?
Just to show the scale of the issue the table on this page, summarised from the IA consultation, lists the charges it sees as important for pooled funds – unit trusts, OEICs and so on.
Investment return | Net of all charges including unit cancellation. |
Investment activity | This information should be given for the fund and not for individual share classes. Figures are not given for derivatives and foreign exchange because there is no consideration paid when entering a contract and their contribution to the value of the portfolio is the accrued profit or loss at the reporting date. |
Turnover | The lesser of purchases or sales divided by average assets over the period. |
Management fees | All income derived by the manager from the value of the pooled fund itself. Payments realised by cashing in clients' units in a pooled fund should also be included here. |
Manager’s fees | All income derived by the manager and associates, except for a performance fee. |
Indirect fees | All charges deducted from the net asset values of underlying holdings of other pooled funds such as, but not limited to, funds of funds structures. |
Other fees | All payments made to parties providing services to the fund other than the manager such as the depositary, custodian, auditor and property-related expenses to the extent these are not included in transaction costs. |
Performance fees | Incurred over the reporting period. |
Transaction costs | Stamp duty and other brokerage fees. |
Other transaction costs | Legal and valuation fees in respect of transactions, expenditure on repairs and maintenance, for example. |
Anti-dilution | Amounts collected in the period from dilution levies and dilution adjustments. |
Securities lending | These are normally shared by the client and the asset manager or appointed lending agent. The disclosure should enable the client to understand the total revenue generated and the proportion of the total they receive. |
Summary
While it is encouraging that the IA is attempting to grasp the charges nettle, it is too late. The RDR forced transparency on advisers, in simple pound terms. The FCA Asset Management Study showed what poor fiduciaries asset managers have been. It is time for the regulator to step in and require a single-number disclosure, in pounds, for all the costs of looking after our money.
David Norman is chief executive of TCF Investment
Key points
The Investment Association has recently issued a new consultation on cost disclosure.
The IA flags that charges are complex.
Dealing costs will vary year on year.
