Mifid II  

The 'Loch Ness monster' rears its head for fund firms

  • Learn how transaction costs tend to be calculated
  • Grasp what these costs could amount to for some of the most popular funds
  • Comprehend the issues that stem from these new disclosures
The 'Loch Ness monster' rears its head for fund firms

Costs matter when it comes to choosing funds, because portfolio fees compound over time and eat into an investor’s returns. Although funds’ returns are always stated after fees, some studies suggest charges can even serve as a useful indicator of future performance.

Morningstar analysis, published in 2016, found that using expense ratios to choose funds helped “in every asset class and in every quintile” from 2010 to 2015, with cheaper products having a better chance of performing well.

The research provider noted that among US equity funds, the cheapest quintile had a total return success rate of 62 per cent compared with 48 per cent for the second-cheapest quintile. This rate continued to fall as fees rose.

As a result, new data showing that the cost of investing in a fund can be much higher than headline figures suggest has been seized upon by transparency campaigners. But all those seeking to draw conclusions should recognise that, in this case, higher costs are not necessarily a bad thing. 

Mifid II rules mean asset managers must now outline the transaction costs a product can be expected to incur over its recommended holding period, typically three years. Higher trading within a fund typically means higher transaction costs – but higher levels of activity within a portfolio can be wholly justifiable. Nonetheless, the figures are eye-opening in a number of cases.

Spotting ‘Nessie’

Transaction costs are already disclosed in funds’ annual and interim reports, but the newest figures are often larger, in part because the calculations use a different methodology (see Box 1). However, the Investment Association (IA), in particular, has come in for criticism for an August 2016 paper that said fund transaction costs were typically minimal and suggested the idea of “hidden fund fees” may in reality be the “Loch Ness monster of investments”.

Analysis of the most popular funds of 2016 by the Lang Cat found that Janus Henderson UK Absolute Return had transaction costs of 0.79 per cent, adding to an already relatively hefty ongoing charges figure (OCF) of 1.06 per cent.

Putting these disclosures front and centre will help advisers and other investors, according to commentators.

“Having the transparency and seeing what you are paying does matter, [and] should up the competition between managers,” says Adrian Lowcock, investment director at Architas.

But specialists have urged intermediaries not to focus exclusively on costs at the expense of a fund’s risk-adjusted returns. “There’s really only three things you need to look at with a fund: performance, performance and performance,” says Jim Wood-Smith, chief investment officer for private clients at wealth manager Hawksmoor. 

“Performance is what matters, and if the fund manager is not delivering on what they ought to be, then the answer is almost certainly to sell the fund and move on.”

With this in mind, Money Management’s analysis, in Table 1 and Table 2, puts costs in the context of a fund’s performance over the past three years. The tables include costs for the bestselling funds of 2017 across 20 different IA sectors, according to Morningstar fund flows data.


Please answer the six multiple choice questions below in order to bank your CPD. Multiple attempts are available until all questions are correctly answered.

  1. What kind of fund may struggle to justify high transaction costs, according to Stephen Peters?

  2. If a fund manager is not delivering on what they ought to, what does Jim Wood-Smith believe an investor should do?

  3. What does Tim Stubbs fear prospective investors may do if they see a fund's high transaction cost figure in isolation?

  4. How have some platforms reacted to the emergence of 'negative' transaction costs?

  5. From the sample of funds used, Old Mutual Asia Pacific has the highest transaction cost figure. What possible reason is suggested for this?

  6. According to Morningstar analysis, what do cheaper funds have a better chance of doing?

Nearly There…

You have successfully answered all the questions correctly, well done!

You should now know…

  • Learn how transaction costs tend to be calculated
  • Grasp what these costs could amount to for some of the most popular funds
  • Comprehend the issues that stem from these new disclosures

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