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.”
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.”
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.”
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.
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