The anti-fund manager invective is misdirected. They are as confused as platforms and advisers when it comes to calculations.
Managing advisory investment portfolios has never been straightforward. The requirement to disclose transaction fees may very well see their demise.
In principle, I am an advocate for transparency. It promotes accountability, and, as a former SEC appointee once opined: “Sunshine is the best disinfectant.” However, it is conditional.
The process of bringing about transparency can produce an accountability gap, where information is in the hands of people who may deliberately cause harm, or who are incapable of using it wisely.
On fund transaction costs, some industry commentators with an eye to the main chance have sanctimoniously lectured on disclosure, pontificating about the griminess of fund groups’ hidden charges, while “outing” the heinous burgling of investors’ funds.
This anti-fund-management stance is just grandstanding. They know transaction costs are not charges. There are not unmarked bills stuffed in a brown paper bag, left for the fund manager’s moll at a dead-drop in Dulwich.
Of course, commentators may have only a shallow understanding of this stuff, unaware that the difference between buying and selling prices – the spread – on shares in Fever-Tree has nothing to do with the fund group, nor does the commission the stock broker charges for dealing.
They may not realise that emerging market bond spreads are wider than gilts, or that, even with zero portfolio turnover, a growing fund has to buy more stock and pay associated commissions. They may also be unaware that purchases of UK equities suffer stamp duty reserve tax. Or that AIM stocks do not.
Anyone who’s ever sold a unit trust should understand the impact of transaction costs. That was and is the purpose of the fund’s bid-offer pricing structure, the higher the costs, the wider the spread. Funds’ portfolio turnover rates are available from data providers. The idea that transaction costs should come as a shock is frankly ludicrous.
I remember training advisers on unit trust pricing in the 1980s, and recall the surprise on their faces when they discovered the bid-offer spread was not the initial charge.
Today’s advisers may be even less familiar with the structure of dual-priced investments, which is a pity given around 20 per cent of all Investment Association funds retain that legal structure – and the bid-offer spread that goes with it.
These days, thanks to platforms, initial charges are pretty much extinct. Technology has dramatically improved global dealing efficiencies; consequently, that spread would typically be around 0.3 per cent. Research costs being absorbed into the fund group’s expenses (out of existing management fees) will see that fall further for most funds.
Unfortunately, while 20 per cent of funds remain unit trusts, 80 per cent are single-priced Oeics – a corporate structure introduced in 1997 to allow funds to be sold to our erstwhile European friends without the quaint British dual-pricing structure that they could not fathom. The result was the dreadfully opaque swinging single -price, the virtually arbitrary dilution levy and, yes, invisible transaction costs.
The anti-fund-manager invective could have some healthy targets, but the attention paid to transaction costs is misdirected. The real issue is how they are now being calculated. In a remarkably laissez-faire moment, the Transparency Taskforce provided a Trump-style dismissal of the importance attached to the method used to account for transaction costs:
“The precise methodology used doesn’t actually matter… we’re going to be moving from an environment of totally inadequate cost disclosure to what will be really good cost disclosure.”
Except it is not really good.
Advisers are already complaining at the utter confusion surrounding the publication of transaction costs, and particularly via platforms: numbers quoted online that do not tally with the resulting illustration (Aviva); data providers publishing negative costs, but platforms showing them as zero (Transact); short-cuts in platform calculations attempting to present total charges in an advantageous light (virtually everyone).
The fact we have some funds showing zero costs is plainly false, since every fund has trading activity through tax, liquidity and stockbroker commissions. Ally that with data providers’ numbers differing via rounding, and out-of-date ongoing charges figures being used, and the chaos is compounded.
Some fund managers are not even sure their external authorised corporate directors have calculated the numbers correctly, since they know they cannot be zero. Again, our commentators may not be aware that firms with external ACDs do not calculate the numbers, or that those ACDs may pass the responsibility to other parties.
Much of the confusion stems from the lack of a common harmonised model to calculate these costs. Mifid regulations specify that firms must only consider costs “which are not caused by the occurrence of underlying market risk”.
Market movements between the initiation of a transaction and its completion (known as “slippage”) should not be included in transaction costs. After commissions and taxes are considered, an estimated spread is calculated to account for implied costs. Using proxy market spreads for each asset class recommended by regulatory bodies, the calculation is straightforward – it is the security’s spread multiplied by portfolio weight, then by turnover rate.
Unfortunately, Priip key information document “Transaction Cost Methodology” explicitly requires the inclusion of market movements. The European Securities and Markets Authority suggested firms use the Priips Regulatory Technical Standards calculation methodology to ensure both explicit and implicit transaction costs are captured, using all trades over the previous three years, for the purposes of both Mifid II and Priips obligations.
Fund managers are confused, as are their ACDs. Platforms are blundering through, while it is the adviser who has to make sense of it all. If you are running portfolios on an advisory basis, you have my heartfelt sympathy.
Graham Bentley is managing director of gbi2, and will be speaking at Money Marketing’s Interactive conference on 3 May. If you’re not already registered, check out the agenda here. Advisers are eligible for free places; contact email@example.com for more details.