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.