A requirement for investment trust providers to include the cost of long-term borrowing in product literature has significantly increased headline expenses and could discourage investors from choosing outperforming funds, specialists have warned.
Under the packaged retail and insurance-based investment products (Priips) rules, investment trusts must provide a ‘summary cost indicator’ in key investor documents (Kids) that incorporates loan interest, performance fees and transaction costs.
The inclusion of gearing significantly adds to headline expenses in some cases. Scottish Mortgage, Baillie Gifford’s £6.4bn flagship trust, has seen its headline expense double. Baillie Gifford said gearing contributed 0.42 percentage points of the trust’s ongoing charges figure, which has risen to 0.84 per cent.
JPMorgan Cazenove research published last year, focusing on UK small-cap trusts, estimated that gearing would add 0.44 percentage points to the cost of the Standard Life UK Smaller Companies product, with Henderson Smaller Companies racking up an extra 0.48 percentage points.
The bank’s analysts, Christopher Brown and Adam Kelly, welcomed additional disclosure but warned of a “material increase” in many trusts’ headline expense ratios.
“Hardest hit, in our view, will ironically be those that have performed well in the past and borne performance fees, those with high portfolio turnover, those with high and expensive gearing and those that own other funds,” they added.
The inclusion of gearing costs is a particular bugbear for firms because long-term borrowing is already accounted for in a trust’s net asset value.
Some, such as Association of Investment Companies chief executive Ian Sayers, also warned that gearing disclosures fail to explain the potential benefits of this approach.
He said: “We have got funds borrowing for 30 years for less than 3 per cent. If they put that in the FTSE All-Share and it’s yielding an average of 3.8 per cent, that isn’t being accounted for [in the Kid].”
Open-ended Ucits funds are exempt from the Priips requirements until the beginning of 2020. As such, analysts have said the disclosures may make closed-ended rivals seem disproportionately more expensive.
In a note published in January, Numis analysts also highlighted concerns that investment trust managers could be discouraged from gearing as they sought to keep headline costs down.
But AJ Bell Investments fund selection head Ryan Hughes suggested such disclosures could push managers to more prudent decisions on gearing.
“It could force people to only do gearing when they are absolutely sure it’s the right thing to do,” he said.
Mr Hughes said of the disclosure requirements in general: “We shouldn’t be shying away from the fact that these are costs.
“Gearing has added to returns in the past few years, but it doesn’t always. It can hurt on the downside, so it’s right that it’s transparent.”
