Richard Saunders: Costs need to be clear for all to see

Costs matter in investment. Just half a per cent a year can reduce your investment by 10 per cent on regular savings over 40 years. So hats off to Matthew Vincent for throwing a spotlight on the issue in recent weeks.

While I would not agree with every detail, I applaud the thinking behind his Fund Fees Manifesto. Costs need to be declared and they need to be transparent.

Funds are required to publish annual accounts every year that set out in detail all the components of cost, together with sources of income including such items as stock lending and underwriting commissions, as well as conventional investment returns. So the costs are declared, but are they transparent? I’ll come back to that.

Spurred on by Matthew Vincent’s manifesto, we at the Investment Management Association carried out an exercise to look in detail at some recent fund accounts. The results are summarised in the table (below). Of the UK tracker funds we looked at, the average transaction costs amounted to just 0.06 per cent of assets. For a sample of actively managed UK equity funds, these other costs were, unsurprisingly, larger – at an average 0.3 per cent (most of which was tax – stamp duty accounted for approaching 90 per cent of transaction costs in the tracker funds and about 70 per cent in active funds).

Should these costs be incorporated into the Total Expense Ratio (TER)? The TER is essentially the cost of running the fund itself. It covers the manager’s charge along with the trustee, audit and other administrative costs. Other costs, such as transaction costs, are the costs of investing. These would be incurred (and would probably be higher) if investors went directly to the market instead.

But the costs are fundamentally different in character. Reducing administration and running costs, and hence the TER, leaves investors better off because lower charges translate into a higher net return. However, to reduce transaction costs, an active manager would need to trade less, which may leave the investor worse off. After all, managers of active funds are supposed to be active. They should be judged, therefore, on their net performance, which takes account of all these factors.

So I would not support combining transaction costs with the TER into some new combined measure of cost. That would risk misleading investors. But I do think all costs should be clear for all to see.

This brings me back to transparency. In working through funds’ published accounts, we were surprised to discover that the information was less easy to track down than we had supposed. Some firms do not publish the accounts on their websites, but make them available on request. And nobody we looked at pulled all the costs together into one simple table.

The industry has a good story to tell, but could tell it more clearly. I would certainly encourage IMA members to think about pulling the figures they already publish into simple summaries. If nothing else, it is an excellent riposte to those who claim that investors face large undisclosed costs.

This issue is on the regulatory agenda. The Committee of European Securities Regulators (CESR) has recently delivered its advice to the European Commission on implementing the so-called “Key Investor Document”, which prescribes the disclosures that all European funds, including UK funds, will have to make. It features a table of one-off, ongoing and contingent charges and will also require disclosure of the broad impact of transaction charges, but not – at this stage – detailed numbers.

It goes on say that “greater clarity and disclosure would be desirable” and says it may return to the question in the future. This is a debate that will continue. I think it is right that it should.

Richard Saunders is chief executive of the Investment Management Association