Light the blue touchpaper, and retire to a safe distance. This firework warning – which, tonight, will be as well-studied by health and safety officers as it is disregarded by hoodies – should perhaps also have been appended to last week’s column: “Total Expenses Robbery – or TER” (October 31). That’s if the e-mails it sparked off are anything to go by. Treason and plot were just a few of the accusations levelled against me, for the apparently incendiary suggestion that the hidden costs of investment funds were a menace.
Anyone would think I’d emulated the villagers of Edenbridge and burnt a fund manager in effigy. There, in darkest Kent, they choose a popular hate figure – if that’s not a tautology – as their 30-foot “Guy”: this year, glamour model and serial autobiographer Katie Price will light up the night sky.
Foolishly, having lit my blue touchpaper, I retired to the dubious “safety” of this week’s Investment Management Association (IMA) annual dinner, and was all but searched for gunpowder. Ironically, it was the 500 fund managers in the room who were actually in possession of the explosive charges.
So, this week, I would like to clear the air of cordite, by giving a say to interested parties. Then, I would like to nominate another model that should prove illuminating.
Joining the side of the Fawkes-ite firebrands, led by renegade fund managers Alan Miller and Vanguard UK, have been analysts, chartered financial planners and a property investment adviser.
One correspondent wrote: “Fees charged by fund managers are the next battleground. I particularly dislike performance fees. You are paid one fee to write well, so why should a fund manager be paid one fee to invest and then another to invest well for clients? It beats me.”
Another e-mailed: “I have always suspected that there was more to this TER business than is stated in investment trust and Oeics accounts but I was not sure – and I consider myself quite a sophisticated investor. Your article is
the first time I have read about how TERs are not the full story on costs of funds. Well done to you.” This rather put me in favour of performance- related columnist fees, though.
A leading fee-based adviser put it more simply: “Whoever invented the term TER – which, as we know, is not the total expense ratio – needs to be shot!” It would at least be a swifter fate than Fawkes’.
Taking up arms on the side of fund managers have been independent financial advisers, a forensic accountant and the IMA. One correspondent argued that last week’s column was “verging on the ‘Number of Angels on a Pin Head’ type of argument” – because the cost of many items, such as running a car, will always be “unknown” – and suggested: “If the level of net performance is satisfactory, are the specifications of cost important?”
But the counter-argument was best put by Dick Saunders, IMA chief executive, who noted that I had only partially quoted his research. “Let me fill in the missing piece. Over the last 10 years, the average UK All-Share tracker fund returned, after costs and charges, 0.55 per cent a year less than the index. The average TER for these funds was 0.82 per cent. This means that the actual costs work out less than the TER, not more. So where are the hidden charges? Moreover, the suggestion that transaction costs are unpublished is wrong. They are disclosed in the fund’s annual accounts, where investors can see them, along with portfolio turnover.”
So, to bring the factions together, let me propose a fund model that addresses all these issues.
Fundamental index tracking – holding shares in an index weighted not by market capitalisation but by fundamentals such as book value – arguably offers cost advantages without inevitable market underperformance.
Turnover is low, as the index being tracked need not be recalibrated frequently. Dealing charges and stamp duty – two of the main “hidden costs” – are therefore minimised. Holdings are not concentrated in the largest companies by market capitalisation, avoiding an overweighting to over-
valued shares. Performance is therefore superior to the index most of the time.
Take the Research Associates Fundamental Index (RAFI) series, which comprises companies with the highest sales, cash flow, dividends and book value. Since 1984, the RAFI UK index has outperformed the FTSE 100 by 3 percentage points on an annualised basis. Over rolling three-year periods, in 23 countries, the RAFI approach has outperformed slowly-rising markets 80 per cent of the time, and falling markets 88 per cent of the time.
An exchange traded fund based on the RAFI approach would only need to charge 0.5 per cent TER and turn its portfolio over once a year, at dealing costs as low as 0.2 per cent. How do I know this? Because Tim Mitchell of Invesco Powershares offers precisely this fund. At the end of September, he had outperformed the FTSE 100 over one, three and five years. That’s one guy I wouldn’t begrudge a penny.
matthew.vincent@ft.com
