The introduction of Mifid II had a huge impact on the investment industry.
While most of the changes are now well integrated into the day-to-day running of funds, there are aspects of the regulation where the ramifications are still being felt.
It is incredibly important to understand the consequences of changing regulation, especially when it affects the end investor.
The topic of ongoing cost ratios is surely one to cause most eyes to glaze over, but it is in this pond where the waves from Mifid II disclosure rules are still rippling.
When the regulation was first introduced, it dictated that fund managers should disclose the extra transaction costs that are charged to their funds, independently from ongoing charges.
The mandate also required independent financial advisers to report every cost back to their clients.
Most fund houses interpreted the rules to mean that multi-asset investors had to calculate the ‘look-through’ costs of any open-ended funds they owned and include those costs in their own total expense ratios or OCRs, on top of annual management charges and administrative costs.
Closed-end funds were not originally included in the regulation – Ucits regulation excluded them.
But recently the Financial Conduct Authority made some changes.
The FCA sought to clarify that investment trusts do fall under the same cost-disclosure rules as open-ended funds and the Investment Association set a deadline of June 30 for managers to get their fund literature updated accordingly.
Full transparency of actual costs and calculation methodologies is crucial to ensure clients know exactly what they are paying for and whether they are getting value for money.
The problem is that the calculation of OCRs for closed-end funds is a fundamentally different process to that of open-ended vehicles.
Investors do not buy the net asset value of a trust; they buy the share price and the sector average trades at a discount (which is widening by the day in this sell-off).
Moreover, there is no apparent consistency in how the underlying trusts calculate their own OCRs, despite guidance by the AIC, and costs for companies doing exactly the same thing vary wildly.
Further, investment trusts are listed securities and have many of the same fixed costs as any PLC – for example, boards, listing costs and audit – but these are not required to be disclosed by equity funds.
As it currently stands, the net result of this change in regulation will be that that OCRs will shoot up across the board because a significant number of multi-asset funds use trusts to gain exposure to alternatives, and these tend to have higher fees than mainstream asset classes.
From June 30, many multi-asset funds have become 20-30 basis points more 'expensive' overnight due to their 10-20 per cent allocation to such trusts.
The changes are complex for financial advisers to explain to investors. While it is hard to measure the full impact of these disclosures, there will likely be several potential ripple effects.
Traditional buyers of closed-end funds will migrate away from the space to mitigate the impact of seeing their own OCRs increase
Multi-asset managers represent around 50 per cent of the shareholder registers of investment trusts.
There is a risk that the new disclosures will cause trusts to derate, new capital raises to dry up and innovative new initial public offerings will not get off the ground.
Having spoken to brokers, many investors are already disposing of trust assets in advance of the June 30 deadline.
Cut off from a flow of capital, UK PLC will suffer
Without investment via multi-asset funds, UK investment companies will not receive the flow of capital they need to support vital areas such as infrastructure and the energy transition, or growth equity and other productive finance opportunities.
Moreover, the UK could see a decline in one of its most respected financial capabilities. Trusts are one of the bright spots in the UK-listed market.
End investors, particularly those in defined contribution pension schemes, will struggle to access interesting, diversifying return streams as part of multi-asset portfolios
Multi-asset funds are a vital investment strategy for many types of investors.
The key growth area of the trust market has been in alternatives and interesting private markets or real assets.
The current macro backdrop proves how useful such investment vehicles are in a portfolio context.
At a time when more DC schemes are starting to understand the benefit of alternative asset classes, this regulatory change risks closing off a viable way for many to gain access to important diversifiers, given the 75bp charge cap.
As it stands, the structure of the disclosure for closed-end funds is simply not fit for purpose.
Including such “costs” as part of the prescribed, single Mifid ongoing cost ratio serves to confuse rather than clarify, and turbo-charges the whole issue of cost over value.
I am confident the ongoing talks between the industry and the regulator will remain productive and an alternative solution will be found, but this may take some time.
Cost transparency and cost efficiency is imperative, but it is clear these Mifid disclosure changes could affect a big part of the population, so the industry must work together to find a better solution.
James De Bunsen is the multi asset portfolio manager at Janus Henderson
