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Analysis: IMA says research backs its stance on TER

The IMA says new research backs its view that a fund’s total expense ratio is an appropriate measure of its costs.

However, some industry commentators have questioned the methodology used by the trade body to reach its conclusions.

The IMA says the research sets out to look at how expected and actual returns are impacted by charges and show whether hidden fund cost charges exist.

It compares investors’ expected shortfall against the fund’s benchmark, in terms of returns minus fees, with the actual shortfall against its benchmark, the fund performance after fees.

The expected shortfall figure compares expected returns after publicly disclosed fees with the fund’s benchmark. It includes costs that are directly quantifiable, such as the total expense ratio, dealing costs and stamp duty.

The IMA says the actual shortfall in returns will take account of implicit costs such as the bid-offer spread and market impact.

The IMA analysed detailed data in the UK all companies sector, alongside data from funds in the global, European excluding UK and North America sectors.

The analysis of tracker funds over ten years shows an annualised expected shortfall of 0.84 per cent in the case of FTSE 100 trackers and 0.69 per cent on FTSE All-Share trackers. The actual shortfall was 0.89 per cent per year for FTSE 100 trackers, while for FTSE All-Share trackers it was 0.79 per cent.

The IMA says part of the reason the actual shortfalls are higher is that average charges for trackers have come down- a fact reflected in the fund accounts but only partially so in 10 year performance figures. It concludes the closeness of the two sets of figures suggests no significant negative impact from the costs that are not displayed in fund literature.

The research also looked at active funds in the UK all companies sector in terms of ten year performance to the end of December 2011.

The expected shortfall was 1.95 per cent, compared to 0.63 per cent actual shortfall.

The IMA concludes that trading costs resulting from active investment decisions are more than compensated by the returns generated from fund manager’s decisions.  

IMA chief executive Richard Saunders says: “What research shows is that the TER really is a good guide to what it is costing you to invest via a fund. Tracker fund returns differed from the market by broadly the amount of the TER.  Active funds did so too on average, if anything a tad better.


He adds: “Trading costs are disclosed, but in documents that most investors rarely, if ever, see.  The IMA will be encouraging the industry to do more here – after all, improved transparency is something that has always worked out well for the industry.”

Bestinvest and SCM Private have questioned the IMA fund research’s treatment on transaction costs in the research.

Bestinvest senior investment adviser Adrian Lowcock says: “The IMA is effectively saying the TER is the right value for investors to use in terms of fund costs.”

“But I cannot see why the IMA has calculated the total expense ratio plus the dealing costs to work out the expected shortfall. If they think that TER is sufficient, I cannot understand why they have not worked out the expected shortfall based on just TER.”  

SCM Private has criticised the research’s calculation of trading costs of active funds based on the 15 largest funds in the UK all companies sector.

SCM Private partner Gina Miller says: “The IMA has just analysed the largest 15 funds by size and the larger the fund the less frequently it normally trades.”

She adds: “According to Morningstar,  the average turnover of all active UK funds is currently 91.6 per cent per annum, but the average turnover of the top 15 funds which the IMA analysed was just 63 per cent per annum.”

Miller also flagged up that initial charges and performance fees were not included in the research and should be included to work out a more accurate figure of cost of funds to investors.

Fidelity Worldwide Investment investment director Tom Stevenson backs further disclosure of transaction costs but supports the IMA’s separation of dealing costs from the TER in the calculation of expected shortfall.

 He says: “I understand where the IMA is coming from in this. Transaction costs are the ones that any investor would incur as a result of participating in the market, as opposed to TER, which is the cost of actually managing the  investment fund.”

Stevenson adds: “We would be supportive of any move that increases transparency of transaction charges. The disclosure of transaction charges is less clear than other charges that make up the TER.”

Hargreaves Lansdown head of research Mark Dampier says performance fees should have been included in the research.

He says: “Performance fees do matter because they are outrageous. They can be 4 or 5 per cent and so they should be included. They are becoming more prevalent and are not transparent.”

Dampier adds: “ I think there is should be one figure for total fund ownership which should include transaction costs if that is what investors want.”



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