Research into hidden charges across the top 20 selling funds of 2016 has shown that investors in 13 funds could have paid as much as 85 per cent more in extra fees than had previously been disclosed.
The Good News For Investors Is That Fund Managers Can No Longer Hide Charges
Are Hidden Fund Charges Really A Thing Of The Past?
Following a change in European rules early in 2018, funds managers are no longer able to combine the cost of research with trading commissions. In addition, they must pay directly for analyst research and make the cost plain in investors' charges.
Fund managers didn’t do this willingly.
It’s happened as a result of something called MiFID II.
What Is MiFID II?
The Markets in Financial Instruments Directive (MiFID) is the framework of European Union (EU) legislation for:
- Investment intermediaries that provide services to clients around shares, bonds, units in collective investment schemes and derivatives (collectively known as ‘financial instruments’)
- The organised trading of financial instruments
MiFID applied in the UK from November 2007, and was revised by MiFID II, which took effect in January 2018, to improve the functioning of financial markets in light of the financial crisis and to strengthen investor protection. MiFID II extended the MiFID requirements in a number of areas including:
- New market structure requirements
- New and extended requirements in relation to transparency
- New rules on research and inducements
- New product governance requirements for manufacturers and distributers of MiFID ‘products’
- Introduction of a harmonised commodity position limits regime
The Lang Cat, a financial consultancy firm, examined the 20 best selling open-ended funds of 2016. It discovered that on average, the cost of these funds was more than 30 per cent more than previously disclosed.
The charges aren’t new. They’ve always been there. But before now, they didn’t need to be declared.
The result was that investors were often under the illusion they were paying much less for their funds than reality.
Funds which change the portfolio holdings more frequently will have greater transaction costs.
This under-reporting of charges doesn’t just apply to active funds. Included in the list were some passive funds from Vanguard and Legal & General that had failed to disclose 50 per cent and more than 80 per cent of the overall costs, as you can see from the table below.
No-one's charges have actually gone up.
Investors have always been paying these fees. It is just that the fund groups now have to tell you what they are charging.
Numerous surveys over recent years have shown how people trust financial services at roughly the levels normally reserved for politicians and estate agents. And with fund groups now saying “Oh, sorry, when we said we were charging you X, we meant a figure over a third higher”, it is not hard to understand why.
This feeling of grubbiness is compounded when you remember just how hard it has been for the industry to step up to the plate and make these changes.
This is not anything radical – all they are being asked to do is to tell people what it costs to invest with them. It has taken EU regulation to get this out in the open, rather than transparency being a rule of thumb.
Now we’ve come this far, we also need those firms who are disclosing a zero cost to explain the basis of their assumptions.
The comments above are quotes from the full article entitled I Would Have Got Away With It Too If It Wasn’t For Those Meddling KIIDs. A KIID is a Key Investor Information Document.
The quoted numbers need to be taken with a pinch of salt. I have spent the last three years working for a Big 4 professional services firm, helping asset managers to comply with the new regulations, so have been at the coalface of this.
Firstly, the method of calculation of transaction costs prescribed by the regulators under MiFID 2 and the related PRIIPs rules is widely regarded as flawed and creating misleading results.
This is because the prescribed calculation method requires managers to capture so-called ‘slippage’ costs. This is where the asset manager is buying or selling assets for the fund, so places an order. It is possible that the price paid or received may change in the time between placing the order and the order being executed in the market.
The regulators have chosen to consider this as a systematic cost to the investor, when in fact it is just normal market movements. In many cases, the price will actually improve, leading to the phenomenon of negative transaction costs – and indeed many funds have quoted negative transaction costs in their investor documentation. Clearly negative costs are a nonsense, but the regulators have insisted that their calculation method be followed, and any negative costs be published as calculated. Cue much investor head scratching – this fund is paying me every time it trades?
Secondly, a number of funds in your list quote zero transaction costs. It is just about possible that an illiquid fund didn’t trade at all over the period of measurement, but much more likely that the manager has simply failed to calculate and disclose costs in line with the regulations. Market readiness for MiFID 2 and PRIIPs on 1st January this year was patchy at best, despite the new rules being enforceable with sanctions. Transaction cost calculation is one of the most difficult areas, and many managers simply weren’t ready on time. So far, the regulators have taken a ‘softly softly’ line.
No-one (except, perhaps, for the asset managers themselves) is likely to disagree that greater transparency on charging is a good thing for investors, but your readers should be aware that the legislation as currently drafted and implemented does not achieve the goal of accurate disclosure. There is heavy industry pressure on the regulators to reconsider their approach, and only when that happens is the nirvana of complete and accurate transparency likely to be achieved. Meanwhile a health warning applies to the numbers the industry is publishing.
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