Fool’s gold: How Mifid II has revealed the true cost of funds

Mifid II reveals true cost of ‘cheap’ funds

Investors may have been paying a third more in transaction costs than previously thought as new European regulation sheds a fresh light on the lack of transparency in fund fees.

Advisers and platforms are quizzing fund groups on the nature of their transaction cost calculations as many commentators say the industry still lacks the ability to make like-for-like comparisons.

Experts say the Mifid II requirements on costs disclosure are an “eye opener” for clients which could lead to wide-reaching ramifications across the advice sector.

Lifting the lid

Money Marketing understands that as a result of the new costs disclosure rules a number of well-known discretionary fund managers are seeing their updated fees challenged, but are failing to provide clarification to clients.

Since 3 January, Mifid II requires investment managers to disclose additional transaction costs that are charged to their funds, separately from the ongoing charges figure. The directive also requires IFAs to report all the costs back to their clients.

As a result of the new rules, clients may not be paying any additional charges, but they can now see separately how much the transaction costs have always added to the total.

According to consultancy The Lang Cat, across the top 20 selling funds of 2016, investors in 13 funds are shown to be paying on average 30 per cent in transaction costs, and as much as 85 per cent more in additional transaction fees than previously disclosed.

Seven of the top 20 funds appear to show a transaction cost of zero, suggesting that these have been absorbed elsewhere in the business.

The Lang Cat consulting director Mike Barrett says the new Mifid II rules on costs disclosure are “a real eye opener”, although the industry has always speculated on hidden charges behind the basic OCF.

He says: “Advisers are starting to have questions in their minds on what it means. But Mifid II also means advisers need to disclose all. The new disclosure is not a big problem if it shows a few more basis points for the funds but advisers need to tell this to clients.

“This is all to make sure the client understands, it is not causing a big suitability problem it is just about having uncomfortable conversations.

“The regulatory theme for asset managers and in the platform market study is value for money and looking at the total cost of ownership. Advisers’ role is to squeeze the costs, but they also want to maintain their level of charges too.”

Fund managers’ fees outed as Mifid II disclosure rules take effect

The Lang Cat analysis shows clients have paid as much as 50 per cent and 54 per cent more in additional transaction fees on the popular Vanguard LifeStrategy 60% Equity and Vanguard LifeStrategy 40% Equity funds respectively.

A Vanguard spokesman says: “Vanguard uses its scale, reach and experience to trade globally at best execution levels to keep transaction costs such as brokerage commissions, dealing spreads, market impact costs, opportunity costs and transfer taxes as low as possible on behalf of investors.

“Our fund managers are paid to deliver tight tracking and seek to control frictional costs at all times; it is in no one’s interest to pay more to execute trades that are not needed. Net performance over the long term is the ultimate return metric.”

The Investment Association responds to the ‘all-in fee’ fallout

In August 2017, the Investment Association hit back at critics of fund management hidden costs, claiming that there was “zero evidence” that funds’ returns are affected by hidden fees.

It said that “hidden cost hysteria” in the industry was misplaced.

In light of the new reporting rules for transaction fees, an IA spokeswoman says: “The Investment Association fully supports transparency of costs and charges so customers understand what they are paying for, from the financial adviser or retail platform, to the fund.  This is now enshrined in law through Mifid II as of 3 January 2018.

“However, the way the new methodology to calculate transaction costs was designed will confuse and mislead investors and could ultimately defeat the goal of greater transparency.

“This was repeatedly raised by the industry throughout the law-making process, with sensible alternatives proposed that would meet the criteria for greater transparency in a way that didn’t confuse the end investor.  Regulators must now listen to the numerous objections across the board and review this damaging methodology as soon as possible.”

Platform puzzle

Advisers have noted a number of funds now appear to show a negative transaction cost figure on platforms.

The Legal & General All Stocks Index-Linked Gilt Index fund was cited as one showing a negative transaction cost on the Hargreaves Lansdown platform, at -8.19 per cent.

However, experts say transaction costs can become negative because of the need to include “slippage” costs under a separate piece of legislation, the Packaged Retail and Insurance-based Investment Products regulation, which also started in January.

Slippage is the difference between the expected execution price of a trade and the actual price at which a trade is executed.

Hargreaves Lansdown head of communications Danny Cox says: “When purchasing a small number of shares, slippage tends to be small, or non-existent, however, fund managers, who often deal in very large volumes, can often receive different prices to that quoted on the market due to the liquidity of the investment when traded in large volumes.

“Where a better than market price has been obtained, the slippage is a ‘negative cost’ and when accounted for with the other transaction costs it can create a negative total.”

Rising prices

According to Nucleus chief executive David Ferguson, more than 1,000 funds on his platform are now disclosing fees up by at least 35 basis points since Mifid II. Aggregate disclosed fund management fees, including transaction fees, are now 25 per cent higher than in December, he says.

Ovation Finance financial planner Ian Else says platforms are revealing fees are different from those advertised. For example, on the Nucleus platform, the L&G UK index fund has an overall cost of 30bps, and not 10bps as advertised.

He says fund charges on the Ascentric platform also show “profound” differences, since they appear four times higher compared to the pre-MifidII period.

Else says: “I’m really surprised by the silence from the fund managers. Only one or two have provided any clarity, the majority haven’t. What the clients are paying has not changes, but the lack of transparency is scandalous. Else says: “Imagine booking a £9.99 flight with Ryanair and being charged £37.99 without your knowledge, which is the equivalent increase from additional charges of a leading index fund. It is misleading and shows a lack of integrity in dealing with clients and the adviser community.”

The Financial Inclusion Centre director Mick McAteer says the new disclosure rules will help bring fund charges down but says this alone won’t help transparency and urges advisers to play their part.

He says: “The fund management industry has been dragging its feet. It is a very inefficient industry. Mifid II should make a difference and make transparency more important. This is where the FCA and advisers have a bigger role to play to bring charges down.”

Capital Asset Management chief executive Alan Smith is in the process of getting “realistic data” on transaction costs and how fund groups are calculating them. Smith says: “As advisers we need to now make estimates on costs. We want to make sure there is a level playing field with a standardised method. Clients are now being told every year how much they pay so it is important for IFAs to have a very strong proposition; they need to up their game.”

SCM Direct partner Gina Miller warns the fallout from costs disclosure could be much greater than expected when it comes to IFAs and their clients.

She says: “We knew [Mifid II] was going to be a shock to people. IFAs now have to go back to their clients and say, in reality, they have always been charged as high as 2 or 3 per cent instead of 1. There is a huge possibility that clients might turn around and say they got missold their funds and claim compensation.”

Miller urges the FCA to come out with a standardised formula for fund groups to use. She says: “Because there is no guidance on how you calculate transaction costs as well as turnover rates or how they work out the spreads, some are overestimating costs, such as the ETFs we use.”

SCM Direct has been using the template requested by the Priips regulation to calculate and report its additional charges. The group uses ETFs only and says charges now look 0.16 per cent higher when adding transaction costs.

Miller says: “Our costs have gone up. This makes us uncompetitive despite the fact that we only use ETFs, but we also see that the average equity fund cost [in the market] now looks 0.5 per cent higher.”

SCM Direct’s research suggests that only three firms are currently fully compliant with the Mifid II’s Article 24 rules on total costs reporting, and will publish a list of compliant and non-compliant firms for the FCA next week.

Industry analysis

Advisers have faced a deluge of Mifid II and Priips transaction cost data from fund providers. They’ve tried to digest this new information against a backdrop of commentary that has been confusing and at times misleading.

One source of confusion is that the regulations allow a number of different calculation methodologies for transaction costs. Among the most popular are the so-called New Priips and Full Priips methodologies. These are equally valid approaches, but they can produce very different results. So comparing provider A, which uses New Priips, with provider B, using Full Priips, is likely to raise more questions than answers.

Even within a single method, there’s room for varying interpretations. Fund turnover is a key input to transaction cost calculations, and you can calculate turnover in several ways. Some of those methods result in negative transaction costs, which seems intuitively odd.

Several commentators have suggested that Mifid II has unearthed hidden costs that the industry has been trying to cover up. In fact, investors have always paid transaction costs – they are a necessary cost that all fund managers incur in meeting their clients’ objectives. Mifid II hasn’t increased prices or uncovered new costs; it has required disclosure of transaction costs with the noble aim of increasing transparency.

Transparency is good, because it tends to lower prices over time. But it will take a while for the industry to coalesce around a single methodology. Until that happens, making investment decisions based on the available transaction cost data may lead to some unexpected outcomes.

Neil Cowell is head of UK retail sales at Vanguard


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There are 16 comments at the moment, we would love to hear your opinion too.

  1. Christopher Wicks 26th January 2018 at 9:16 am

    Funny attempt to make vanguard look bad! Their overall costs are still far cheaper than the others in the sample!

  2. This whole MIFID 2 debacle both charges and reporting investment drops is such a mess. To keep abreast of it all as a small firm is nye on impossible. I have seen some horrendous cost increases in some of the portfolios that I use. Some charges as in the table above have even doubled which is outrageous.

    As for reporting 10% drops, surely if you have educated your client accordingly and recommended a risk profile suited to their circumstances, expectations and needs, then they will be prepared for volatility. Why create more work, more expense and more information that could potentially panic and confuse clients? What’s the point?

    All MIFID has done seems to be to have over complicated an already complicated industry. Who does this benefit? Yes charges on these funds should be much more transparent. If you buy something of course you want to know the full cost, but maybe these policies should be designed and tested before just throwing them out there to confuse everyone.

    While we are on the subject, th FCA should have better telephone support/face-to-face support for the smaller firms not just an open door for the big firms. We need people who can tell us what we should be doing rather than pointing to a mammoth section of a book that’s written in legal jargon! Otherwise are we getting value for money in our fees? Probably not. We have to pay for compliance support & FCA plus FSCS and PI Insurance!

  3. The bottom line is that well-meaning regulations have been badly implemented. The result is 2 steps forward and 1.87924 or 2.15649 steps back (depending on whether you use method A or method B).

    Neil Cowell has been rather kind when saying “So comparing provider A, which uses New Priips, with provider B, using Full Priips, is likely to raise more questions than answers.” Put more simply, valid comparisons can’t be made. Transparency is good but not when there are several different versions.

    And, yes, regulators were made aware of all this long ago but seem powerless to do anything about it. Politically, job is a good’un, transparency achieved. Advisers have more information and the wherewithal to understand all the nuances which is good. Clients have more information which for most will be at best misleading.


  4. What a surprise that the rampant self-publicist Gina Miller gets her oar in, stirring up clients to make ‘mis-selling’ claims. It’s not the least bit helpful, and of course ehe seeks to self justify by claiming that the funds she uses are over-estimating their charges.
    Well boo-hoo Gina, stirred it up over Brexit trying to deny the will of 17 odd million, stirring again over this.

    • Your post sounds more like a case of rampant misogyny.
      Why only mention Miller as a self publicist? What about Neil Cowell? What about Alan Smith? They both contribute to the above article.
      Perhaps you just don’t like women that are able to argue a point coherently (and have also found their points to be correct in law).

      • Well said Patrick.

      • I don’t think so.

        I think it is An Adviser is simply another Brexiteer who thinks they are entitled to disenfranchise all who disagree with them and use any excuse to attack them.

        (I do NOT think that is true of all people who voted to leave, but it is true of some).

        What Gina Miller actually said is there is a POSSIBILITY that might claim they were missold. She did NOT say they were missold and she did NOT say they were entitled to compensation.

        But hey, what has the truth got to do with it? Any excuse to attack somebody who dares to voice an opinion I do not like.

  5. I’d like to see SJP and other vertically integrated firms’ post-MIFID 2 cost disclosures on their funds. Or will side-step this like with RDR’s commission ban?

  6. Can anyone explain the difference with the ‘new’ rules and the Total Expense Ratio figure which was replaced by OCF?

  7. Farcical, farcical and the FCA allows crass regulation to appear on the statute books knowing full well it is confusing, fails to provide clarity to consumers and is actually inappropriate for the UK market. Who was responsible for this trash?

  8. It’s even more of a farce when the rules for “disclosure” are being interpreted differently by different managers.

    So we have some managers disclosing some costs and others saying “it’s included”.

    Are we trying to suggest that clients don’t actually pay when it’s “included”.

  9. A good article by Valentina and congratulations to The Lang Cat for highlighting the issue. All this reminds me of when I introduced Key Facts in the 90s and the life industry had a collective fit of the vapours when it was shown in cash how much could be taken out of a policy in charges and expenses over 25 years. It was claimed it would “confuse and mislead” consumers. And if that argument did not work, that the calculations were wrong. The investment industry is now trotting out the same shoddy excuses. Four simple questions. Have there been hidden costs – yes. Has the investment industry been transparent about these – no, it has needed the EU to force disclosure. Does it matter to consumers – yes, it may be that managers have been getting good returns (difficult not to with rising markets over recent years) but if some of the hidden costs were lower (in particular, cut out the Scooby Snacks) the returns to consumers would have been higher. And finally, is it not the part of an adviser to explain to clients things which they might find confusing?

    • Have there been hidden costs – yes. And probably still are

      Has the investment industry been transparent about these – no. This forced disclosure is a step in the right direction but it missed a trick and could have been defined and communicated so much better.

      Does it matter to consumers – yes. Well, yes it matters academically speaking but for 90% plus of individual clients they have no interest – that’s why they have advisers.

      Is it not the part of an adviser to explain to clients things which they might find confusing? Yes, but it shouldn’t be their job to correct what a regulator has forced them to provide.

      What shoddy excuses do regulators have for making no real difference over the last 30 years? What did commission disclosure achieve? What did Key Facts achieve? What have overly complex rules achieved? What will the latest round of confusing and misleading ‘transparency’ achieve?

      When former and current regulators point the finger they should remember where the other three fingers are pointing!

  10. Grey Area hides behind a alias to have a pot shot at this ex-regulator,he or she won’t be the first one! Yes, a lot of clients don’t take much interest in the written bumph but that does not mean they should not be given the opportunity to read the material. That’s what transparency is about. And on Grey Area’s estimate 10% of clients do take an interest.

  11. In what way does this provide transparency if different firms use different methods to show charges? There HAS to be uniformity, otherwise what’s the point? It could lead to less transparency, not more.

  12. I have been looking at an old decision by ombudsman Keith Taylor in a case where the complainant said the illustrations were wrong.

    Taylor said:

    “While I note [the complaniant]’s points regarding the growth rates used in the illustrations I
    appreciate that he will not be pleased to hear that I am going to reiterate the points made by
    our adjudicator. The illustrations were prepared by [the provider] in accordance with
    guidelines laid down by the then regulator, the Personal Investment Authority (PIA). Neither the [adviser] nor [the provider] were required to use lower growth rates than the 5%,7.5% or 10% per year that were quoted in the illustrations at the time.”

    This is an old case and predates the publication of ombudsman decisions but I think it forms the basis of a defence of any complaint along the lines Gina Miller suggests.

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