A row has broken out between the Investment Association (IA) and transparency campaigners it accuses of hysterical claims of massive hidden fees it says are as realistic as the Loch Ness monster.
The IA has published research it says shows hidden costs are a fraction of the level claimed by transparency campaigners and that investors are not losing out under the current structure.
Transparency Task Force member Con Keating, of Brighton Rock Group, has responded by describing the research, carried out with Fitz Partners, as ‘the worst of the hundreds of empirical financial studies and reports’ he has ever read.
The IA paper argues that if there are hidden costs then funds would, on average, underperform the benchmark return by at least the sum of ongoing charges and transaction costs. But, it argues, averaged across all IA equity sectors, funds outperformed their benchmark in 2012-2014, meaning fund outperformance overcompensated both the ongoing charges and the transaction costs. In 2014-2015 funds underperformed the benchmark but only by 37 bps – far less than the shortfall of 156 bps that would be expected as a result of the alleged costs of overtrading says the IA.
In a lengthy rebuttal of the report, Keating says the research is not robust as it does not clearly define the basis for the benchmarks used, and uses a limited and arbitrary data set covering two 12 month periods and one 11 month period. He also questions the report’s assertion that in 2013/14 the average UK equity fund manager added 649 bps performance above benchmark.
The paper also ignores the issue of research paid out of investors’ funds through bundled research costs, which is used to pay fund managers’ research costs. Frost Consulting estimates that around a third of the $22bn execution commissions paid in 2011 went to pay fund managers’ research bills. The FCA estimates at least £1bn of UK commission costs, paid out of customers funds, have gone to pay fund managers’ charges. In 2013 then FSA chief executive Martin Wheatley said: “The prevalence of bundled services, combining eligible with non-eligible services, can disguise overpayments for eligible services. This cross subsidises services that asset managers should pay from their own funds.”
The IA research found that across the 16 sectors for the three periods 2012/13, 2013/14 and 2014/15, in 25 instances the average sector return was higher than benchmark returns – coded green on the graph – and in 8 instances was negative but less so than the expected shortfall based on the increased cost of active management. In 15 cases the realised outcome was more negative than the expected shortfall – red colour- coded – but in 10 out of these the difference was less than 1 percentage point.
The IA argues that while it accepts this is a relatively short-run dataset, the analysis shows that on an asset-weighted basis, there is no evidence of significant hidden costs damaging investor outcomes.
The IA research found on an asset-weighted basis, transaction costs across IA equity sectors between 2012 and 2015 were 17 basis points, the result of an average portfolio turnover rate of around 40 per cent.
Given an average bundled OCF of 142 basis points, it argues, fund returns would be expected
to fall short of benchmark returns by 159 basis points – the sum of 142 and 17 basis points for the OCF and the transaction costs respectively.
But funds actually covered both ongoing charges and explicit transaction costs and delivered returns higher than that of the benchmark.
The analysis is based on the Fitz Partners Transaction Fee dataset published in October 2015. This includes data from annual reports of open and closed, active and tracker funds across all IA sectors.
For UK All Companies, transaction costs average 19 bps across both trackers and active funds in 2014/15, with trackers posting trading costs of 4bps compared to 23bps for active UK All Companies funds. Portfolio turnover for UK All Companies trackers stood at 13 per cent in 2014/15, compared to 40 per cent for active UK All Companies funds. However, specific fund data shows that the range of levels of portfolio turnover can vary hugely from fund to fund.
An FCA paper on charge transparency and conflicts of interest in the asset management industry is expected in September.
Investment Association director of public policy Jonathan Lipkin says: “The industry should be judged on its actual delivery, not on perceptions of delivery. Our research with Fitz Partners is a detailed empirical analysis of equity fund performance in the context of quantified charges and costs.
“If you look at the actual performance delivered to fund investors, this is the proof point and we do not see evidence of high transaction costs, either explicit or implicit.”
Fitz Partners founder Hugues Gillibert says: “I am extremely pleased with our cooperation with the IA in the building of this thorough analysis of funds costs and performance. This research paper is long overdue and I trust it will be welcome by all stakeholders: investors, fund distributors, asset managers and also industry commentators.
“This research makes no judgement as to what could be considered the right level of fund fees or what could be qualified as cheap or expensive, but by taking into account all costs borne by the funds and in turn by the investors and its potential impact on funds returns, it measures the actual value added by performing asset managers and the unlikely presence of significant transaction costs.”
Keating says: “There is a real problem with the benchmarks used as comparators in that these are presented without any description of their compilation. In 2012-13, the (simple average) active benchmark reported was 13.61 per cent and the tracker 17.27 per cent, a huge difference not present in any other period, which simply demands explanation. The weighted average was slightly less extreme at 14.71 per cent and 16.84 per cent. Both are implausible.
“Bundling and averaging these different mandates simply serves to confuse and possibly mislead; it would have been so much easier to interpret had the various FTSE and AIM mandates been left separate and compared with their usual – market cap weighted – benchmarks. The radical departure in this report from all other studies that I have seen is that it reports that active fund management adds materially to performance. It seems that active fund managers are very consistently able to add value across mandates – a further finding not reproduced anywhere else, in my experience.
“We are asked to believe that, in 2013/14, the average active UK fund manager added 649 basis points relative to the simple average benchmark (555 basis points weighted). Quite apart from the significance of this one figure to the overall average quoted repeatedly, this level of gain is more commonly associated with highly leveraged hedge funds, even if rarely achieved by them.”
Transparency Task Force chair Andy Agathangelou says: “The OCF often fails to include all the implicit costs, custodian transaction costs, one-off costs and so on. In time we’ll forensically examine the research and the central question we’ll be asking is: How complete is it?
“But if the IA are convinced it is complete then perhaps the IA would be willing to stand by it and guarantee to pay compensation to any investor that ever has, or ever will, pay any kind of charge beyond what is disclosed in this research? So there’s the challenge to the IA – if the IA believes the research to be complete they can stand by it if they want and provide a written guarantee to any investor that ever has, or ever will pay any kind of charge – explicit or implicit – beyond what is fully accounted for in this research. I wonder if we’ll ever see such a guarantee from the IA. Maybe we’d see the Loch Ness Monster first.”
Hargreaves Lansdown senior analyst Laith Khalaf says: “The debate over charges has undoubtedly been characterised by exaggerated and sometimes baseless claims, but at its root there is an issue over the disclosure of charges which the funds industry needs to get to grips with.
“The problem lies in the transactional charges incurred by funds which appear in the annual reports and accounts, but don’t appear in the Ongoing Charges Figure disclosed by funds on their factsheets.
“There is a genuine question over the correct presentation of these charges, because they are variable, and so an annual calculation may give a misleading impression of the regular costs to investors. Events like manager changes and extreme fund flows can create spikes in turnover and transaction costs, despite being non-recurring by nature. The Investment Association is consulting later this year on standardising disclosure of such costs.
“Transaction charges are an important factor in returns, but most fund managers are rewarded based on their performance, so won’t trade unless they believe it will be of benefit to investors. The issue is therefore one of disclosure rather than mis-placed incentives.
“Investors must also take performance into account when choosing a fund, in reality the dispersion of returns is much more heavily influenced by manager skill than charges. Over the last 10 years the best performing UK stock market fund has returned 12.7 per cent a year, the worst has returned just 1.2 per cent.”
