Trying to understand investment management fees can be a challenge for investors. There’s an old saying about buying cars: no matter what the bodywork looks like, you should always look under the bonnet before committing to the purchase.
The same applies to investment fund purchases. Marketeers are experts when describing their particular fund offerings’, the many positive features and uniqueness. In many cases, however, negatives are harder to find and quantify. Financial advisers are now expected to provide so much information to potential clients that even the most investment-savvy can miss clear indicators which should make them think twice.
Costs, fees and charges are very much in this category. Despite all fund providers being obliged to declare all fees in their marketing documentation, many investors either aren’t informed about them by their advisers until it’s too late or are given semi-factual information.
‘Fact Sheets’ are usually the first documents potential investors see. Fact Sheets provide information such as the fund’s full name, size, domicile, regulatory status, i.d. codes, management team and style, benchmarking objectives, risk rating and ‘Annual Management Charges’ (AMCs).
Past performance figures are presented in net terms over different periods and represented as percentage increases/decreases of growth in the fund. Fact Sheets also provide useful information regarding which industry sectors and geographical areas the fund invests in, as well as the top 10 holdings.
Fund managers must also provide Key Investor Information Documents (KIIDs). KIIDs are dry information sources, but studying them before committing to an investment fund is important. Much of the information provided on Fact Sheets can also be found on KIIDs, without the colourful Pie charts and well-spaced-out narrative.
One of the most important aspects of investment management fees in the KIID is the ‘Total Expense Ratio’ (TER) and/or ‘Overall Charges Figure’ (OCF). Essentially, they are the same, so I’ll only refer to OCF. Either way, they illustrate the true cost of buying the fund.
OCFs comprise of the AMC of the fund plus additional expenses that the AMC doesn’t specifically cover. So, Director’s fees, Custodian fees, Forex charges and additional marketing fees are included. This list isn’t exhaustive.
The OCF will therefore always be higher than the AMC. How much depends on the type of fund on offer and the company that manages the fund. The AMC/OCF spread can vary considerably from one fund to another, so it’s imperative that you know the difference before investing.
Some funds allow initial fees to be paid as well as the annual charges. This is also something to be aware of before purchasing the fund.
Investment management fees in action
Let’s look at what might be considered good and bad practices without specific names. These examples are based on real funds and figures.
Fund A. is managed by a well-respected international fund management company in a specialist sector. Plenty of information is provided in the Fact Sheet, including the all-important OCF figure. 0.80% per annum is good value in a specialist sector, so I would say the pricing is fair, and the information is clear and not misleading. Additional sales commissions aren’t allowed.
Fund B. is a mixed fund of individual shares and funds in the global sector. The portfolio allocation is pretty standard, including mainly US household names. Doesn’t look too much different from a low-cost index or Exchange Traded fund (ETF). An initial sales commission of up to 5.50% is available for introducers, and the Fact Sheet only quotes the AMC of 1.85% per annum. Digging deeper under the bonnet and checking the OCF, this fund’s real cost is a whopping 2.35% per annum. Conclusion? Poor value, and this fund will have to work extra hard to beat the global index. The fund is c.70% invested in the USA, so is it really ‘Global’?
Investment management fees aren’t the only consideration when allocating funds to a portfolio. If they were, no specialist varieties would exist, and fund managers would be out of work as the machines take over with algorithmic programmes.
ETFs to the rescue
There is a strong case for automated fund management as ETFs are becoming increasingly popular. ETFs are managed by algorithms which automatically change the allocation of shares in an index according to the relative changes in individual company size.
Further, most ‘active’ fund managers don’t beat the index in the major markets. It’s estimated that 70% of active fund managers fail to outperform the index of the market in which they invest. The main reason is that far too many don’t invest much outside the index, and charges are considerably higher. If we take the example of Fund B above, the managers would have to outperform an equivalent ETF by 2.35% per annum to equal growth.
This isn’t to say ETFs answer all investment allocation questions. In specialist markets such as individual country funds, sector funds (Biotech, AI, Infrastructure etc.) and smaller markets, the situation is reversed, with 70%+ of active managers out-performing the index. One of the reasons for this is that in smaller markets, one or two shares can dominate an index. A good example was emerging technology indices when a group of investors artificially ramped shares in Game Stop to make huge gains in the short term, then sold out before the inevitable share price fall.
It therefore makes sense to construct your portfolio using a combination of ETFs and Active funds, allocating according to your risk profile and tolerance for loss. Specialist active funds can access sectors of the economy you may be particularly interested in, such as Sustainable Energy, Private Equity, Technology etc. Index funds and ETFs aren’t usually appropriate for this part of your overall portfolio allocation.
To summarise, several factors need to be considered before buying a fund. It’s vitally important to look under the bonnet and demand full information about the history, all forms of investment management fees and future expectations of the fund. Remember, one size doesn’t fit all and creating a bespoke solution will usually be better for you in the long run as well as being lower cost. Value for money is paramount, and where multiple layers of management exist, multiple layers of charges will always follow.
‘Under the Bonnet’ checklist:
- How long has the fund been in existence?
- How large is the fund?
- Ask for OCF figures as well as AMCs. If substantially different, ask why.
- Have you been given KIID documents?
- How long has the manager or team been in place?
- Can an ETF do the same job for lower investment management fees?
- Does one particular share dominate the fund?
- Does the fund meet your ethical investment requirements?
- Does the fund meet your currency requirements?
- Do you feel that you are being advised or sold to?
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