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IMA’s Godfrey: Fund costs and performance – does it have to be so complicated?

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The search for a way to explain fund costs and their impact on performance in a way that actually helps consumers, rather than leaving them scratching their heads, may not have cost as much blood as the search for the Holy Grail, but it probably has cost as much in treasure and generated many times as much heat as light.

The reason we’ve failed so far is that as “experts” we’ve been asking too much of a solution.  We want it to be accurate to ten decimal places, personalised to every investor, to work equally well for a unit holder as for a prospective investor, to encompass the known outcomes of the past as well as the uncertainties of the future.

A wise former Chairman of mine was fond of saying: “Don’t let the best become the enemy of the good.”  We shouldn’t allow the search for perfection to stop us from getting a really good answer.

As an industry, this search for perfection has left us accused of obfuscation – that we must have hidden charges and we want things to stay that way.  It may be unfair, but it’s up to us to develop ideas that achieve something really useful and robust if we want to move on in an environment of trust.  And this is essential if asset managers are to fulfill their potential to make an important and positive difference both to consumers and to the economy.

So I have a proposition that I want to ask a broad range of stakeholders to help me with.  This includes asset managers, clients, advisers, the media and consumer representatives.  I want us to work together to build a simple solution and to develop a methodology that makes customers better informed without needing a PhD in fund accounting.

Accounting to our clients for what costs have actually been is one thing.  It is a fundamentally different task from giving prospective investors a sensible idea of what future costs, that can only be guessed at, may be.

Let’s see if we can deal with historic costs in a way that gives our investors a simple but robust measure of the real costs that have been incurred and in the context of the real performance that has been achieved.

The idea I want to discuss takes, as its starting point, the fact that for any fund’s accounting year, we know exactly how a unit has performed and we also know every penny that has been spent by the fund (or allocated to a share class).  This could be annual management charges, administration expenses, audit fees, performance fees, dealing commissions, stamp duty, foreign exchange dealing costs or anything else – it’s all been spent and it’s all been recorded.

The proposition is that if we calculate the average number of units in issue on a daily basis over the year and divide that into the total costs, will we get a reasonably robust approximation of the costs incurred by a unit held over the full accounting year.

This would allow a very simple statement of costs and performance to be given to investors.  For example, for a fund whose accounting year was the same as the calendar year we would be able to tell an investor who had bought and maybe sold some units during the year:

“You held 3,456 units on January 1, 2012 with a value of £4,320.  On December 31, 2012, you held 5,140 units with a value of £6,939.

“For a unit held throughout the whole year, the price went from £1.25 to £1.35, a rise of 8 per cent.  The total costs for a unit held throughout the year were approximately 2.5p per unit.  The costs were equivalent to a quarter, or 25 per cent, of the growth in the value of a unit.”

Of course, nothing is ever that easy.  We may hit bumps along the way, which could throw up anomalies where this method produces misleading results.  But if and when we hit these bumps, we should seek to find adjustment factors that we can all agree on rather than saying “it can’t be done” and giving up.

I’ll accept criticism that this method doesn’t cover initial or exit costs.  But those can be, and are, precisely expressed and disclosed separately, simply and transparently and shouldn’t get in the way of a robust way of accounting for costs and performance of units held throughout the year.  

Nor does it cover advice or platform costs.  Of course, where an adviser or a platform is involved, we’ll be handing our number over to them and it will then be their responsibility to include it and to add their own costs to the statement.  But again, these costs will be known and can easily be expressed and included.

If we can get to the right place, this simple historic cost number should be all that the vast majority of clients ever want to see.  But for those clients who want to see the breakdown, for advisers, fund analysts and journalists, they should be able to drill down to the individual line items to see approximate values within the total.  And for some costs, perhaps a third layer should be made available – for example the dealing commissions spent by the fund broken down into execution cost and amounts that have been allocated to brokers in respect of research services received by managers.

If we can succeed with this style of historic cost and performance date, we will start to build a series of data points year-on-year, which are of utility not only to existing clients but also to those researching the future.

In respect of potential future costs, the disclosure requirements of the KIID are a pretty good measure (which should be extended to all investment funds).  The IMA’s Enhanced Disclosure guidance adds even more information – but the inevitable limitation is that we cannot know all future costs.  The fact that we do know all actual costs and actual performance for the past is why the single-figure historic cost number is so important.

And it’s why we have to play a part in educating consumers about value not just price.

The historic cost proposition discussed here could be a big step in the right direction, presenting, as it does, performance against cost in the same place and in a simple format.  But ultimately it’s a superficial value statement and gives the client no clear steer as to whether they should be pleased or disappointed with the outcome.

I think there may be ways that we can work towards more comprehensive value metrics, but one step at a time!

Let’s first work together to see if we can build a simple once-and-done number that gives an idea of value and which gives clients a good indication of what their performance has been and the costs they’ve incurred along the way.  In doing so, asset managers can move on from this debate and concentrate on fulfilling our purpose – to justify our clients’ trust and confidence in us that we will help them make the most of their long term savings and investments.

Daniel Godfrey is chief executive of the Investment Management Association

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