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Tony Byrne: The FCA must put a stop to hidden charges

Tony Byrne

There has been much debate over the years around the subject of portfolio turnover rate, which represents the hidden charges levied by funds not disclosed by the ongoing charges figure.

When key information documents were introduced in July 2011, the requirement to disclose the PTR was abolished. Many people at the time saw this as a retrograde step. In the interests of investors, surely it makes sense to make full disclosure of costs?

The FCA has introduced the OCF to replace the total expense ratio but done nothing in respect of the PTR. One of the issues has been the way in which it has been calculated previously, with the formula having the effect of doubling the charge.

However, this can be overcome by taking the lower of the shares bought or sold figure and dividing that amount by the average fund size during the year.

The PTR calculates the amount by which a portfolio is turned over or changed during a year. Some might call it churning. So, if 100 per cent of the shares are sold and replaced, the PTR is 100 per cent. Such a rate of turnover will incur higher dealing fees, more bid offer spreads and greater taxation costs than a fund with a lower PTR.

It stands to reason, then, that a tracker fund representing an index, such as the Vanguard S&P 500, has a PTR of just three basis points.

There are many studies on passive investing by way of low-cost index tracker funds and exchange-traded funds that show they outperform active strategies most of the time.

So this is a secret that active fund managers do not want the public to know about. However, it is all starting to change.

Hitting home with consumers

Investors need to be openly informed of the full impact of charges on their portfolios. The FCA has a duty to enforce full disclosure of the PTR on fund managers – if for no other reason than it is quite simply the right thing to do.

You cannot help but wonder why it has not enforced full disclosure in the UK when it is compulsory in the US. Is it because the fund management industry here is so rich and powerful it carries far too much lobbying power and influence on the regulator?

And why change the term TER to OCF? The cynic in me thinks maintaining the former would imply full charges, including PTR. The latter term is a totally watered down description, obviating it.

“You cannot help but wonder why it has not enforced full disclosure in the UK when it is compulsory in the US.”

SCM Direct has calculated the average PTR in the UK is 38bps. This means the average OCF of 85bps is understated by 45 per cent. That is a significant under-reporting of the TER, to use an old term. This is a scandal that needs to be addressed by the FCA – and the time is now.

Tony Byrne is financial planning director at Wealth And Tax Management and author of Wealth Magic

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Comments

There are 4 comments at the moment, we would love to hear your opinion too.

  1. This comes across as nonsense. Is the PTR a percentage (e.g. 100% turnover) or is it the cost of dealing in shares, like 38 bps? Even the latter cannot be directly compared with OCF since OCF is a direct cost which reduces performance by exactly the same amount whereas dealing charges may (indeed are designed to) increase performance and may succeed in part or possibly even not at all if the ‘wrong’ shares are sold or bought, in which case the reduction in performance may be even greater than the dealing cost. Without a thorough ‘performance attribution’ investigation the mere disclosure of either the rate of turnover or the cost of dealing by themselves are thoroughly misleading.
    Of course, even active managers can have very low turnover rates since ‘active’ refers to cerebral activity, deciding which shares to own and possibly sticking to them rather than continually changing whereas passive has been accurately described as ‘brainless’.

  2. Recently I was trying to work out what the charges were on the Brooks Macdonald Managed Portfolio Service (MPS), and was told by them, that the OCF includes the PTR. From your article it would appear that this isn’t the case, or do they have the option to include it or not in the OCF?

    • I am fairly sure (at least that’s what their brochure says) that the Brooks MacDonald MPS, like many DFM portfolios, consists entirely of collectives (i.e. funds), not shares. So there are two layers of charges, for the underlying funds and BM. It is common for the DFM OCF to include the fund OCF. So if the BM AMC is 75 bps, the total OCF is likely to be 50 bps or more higher (including the discounted AMC deal they have with the fund managers who actually get the money to invest). OCF on most funds is normally only 5-10 bps higher than the AMC – the extra in this case comes from the involvement of a double layer of fund management. VAT on BM’s AMC is an additional charge but not included in the OCF number – so the effective OCF paid by the client is even higher. None of this takes dealing/transaction charges into account, either in the funds or in the BM Portfolios.

  3. Some ‘clarifications’ required here. PTR publication requirement was waived via UCITS IV legislation, not FCA, but that’s incidental.

    See the phrase “SCM Direct has calculated the average PTR in the UK is 38bps. This means the average OCF of 85bps is understated by 45 per cent.” PTR is a ratio, not a charge – it’s a ratio of the lesser of value of securities bought or sold, as a proportion of the average AUM in an accounting year. Any charges depend on the floating costs of the associated transactions. The calculation of the basis point cost contains a huge number of variables – Small Cap funds will have higher transaction charges, even with lower PTR, given commissions are higher and spreads wider. Meanwhile Large Cap trading commissions are verging on zero, given the trading volume. In my recollection, in 2011 SCM (Allan Miller’s business) calculated the average UK All Companies fund had a PTR of 89 per cent. But you then have to determine the huge variation in stock spreads depending on liquidity and market conditions,competing brokerage commissions (again dependent on trading volumes) and so on. This makes PTR potentially misleading – particularly as a predictor of performance – unless more fully explained. That’s in part why the requirement was waived.

    As for the ‘scandal’, readers will be aware the FCA’s report MS15/2.2 has sensibly recommended that transaction costs need to be explicit, irrespective of PTR. gbi2’s response to the FCA report, both in person and in writing, was to make transaction charges explicit, reported alongside OCF, on the reporting anniversary i.e. a calculation, not an estimate. It should not only appear in the report and accounts, but feature in any material where the OCF is quoted. Any poor comparative performance can then be compared to respective competitors’ charges. Likewise, good performance – perhaps in spite of higher costs – can be highlighted.

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