May 2017

OPINION: Fund fees - the issue that will not die

Fiona_RintoulFor what feels like the gazillionth time, fund fees came under scrutiny last month. Like sky-high executive pay, tax-dodging and expenses fiddling, opaque and excessive fund fees are an issue that just will not die. Wherever there is a fund expense, it seems, there is also the temptation to overcharge and dissemble. Why does it keep happening? Christopher Traulsen of Morningstar hits the nail squarely on the head in a recent briefing document. “The relationship between fund houses and fund investors is not a well-functioning market: one side, fund houses, holds a decisive information advantage over the other, investors.” The briefing document, entitled ‘Finding Hidden Fund Fees’, goes on to complain about the dual pricing mechanism used by most unit trusts. The difference between the issue and redemption prices is meant to cover the sales charge and the cost of executing the trades needed to issue or redeem units. That would all be fine and dandy, except that the trades often cancel each other out, meaning there are no costs, but fund managers still trouser the fee. This is quite literally money for nothing. Traulsen advocates banning dual pricing, and no doubt he is right to do so. But one can’t help feeling there is something more fundamentally amiss here – a kind of mentality glitch – that a ban won’t fix. Meanwhile, Lane Clark & Peacock’s (LCP) sixth survey of investment management fees, released in April, reveals a cornucopia of what the consultancy terms “fee paradoxes”. The first is that while median fees are down in most cases, total fees are up because of the strength of investment markets. In fact, the cost of investing in a global equity portfolio has gone up by 70% since LCP’s first survey in 2011. That could be OK if the portfolio were being brilliantly managed by investment geniuses, but this is not the case. According to LCP, managers increased their fee levels regardless of whether their returns were above the benchmark they had set themselves. “We learnt that managers who failed to hit this benchmark return were still benefiting from materially increased fee levels because of the general rise in market values,” says Matt Gibson, a partner at LCP, who goes on to ask why investors are rewarding mediocrity. Why indeed. Partly because of the information advantage identified by Traulsen, no doubt, which is exacerbated by confusing costs. COFUSION REIGNS Later in its survey, LCP highlights one area where confusion reigns supreme: transaction costs. Among the 77 responses LCP received from 126 asset management companies, it found a difference of £380,000 between the minimum and maximum transaction costs reported for a £50 million UK equity mandate. This is basically due to lack of consistency. “The differences are down to varying approaches and different items included in the transaction costs,” says Gibson, who also hints at a reluctance to discuss transaction costs.  Morningstar, too, is exercised by transaction costs, which Traulsen says should be “baked into the cost figure given to investors”. There is no reason why this can’t happen as both explicit costs and implicit costs “‘are measurable costs that fund investors bear on an ongoing basis and should be clearly disclosed as part of any cost ratio”. Indeed. And why not talk about a flat fee for fund management services while we’re at it? There is something deeply depressing about the self-interest around fund fees. It’s a bit like being in a restaurant with someone who is undercharged and doesn’t tell the waitress. One hopes for a moral awakening. But too often it doesn’t come. Fiona Rintoul is edtorial director at Funds Europe ©2017 funds europe

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