Most investors can usually see the Annual Management Charge (AMC) and additional expenses being charged, but is that all that matters?
Various types of funds have different charging structures. In the most basic form, you see an AMC, but when delving into some of the other costs, it can be difficult to really understand the true costs of an investment.
Many funds have additional expenses which cover administration and custodian charges. Others have initial charges for making an investment. Going into a bit more detail, funds may have a ‘fund of funds’ structure which has third party manager fees, active funds may have performance fees, or a fund may be invested via a platform which has its own platform fee.
More illiquid asset classes, such as property, have additional costs such as the management costs of the underlying properties (Property Expense Ratio). This does not include the costs of buying and selling investments, which can also have explicit costs such as dilution levies, or implicit costs associated with the bid-offer spread.
As you can see, the headline cost quoted on a fund is rarely the true cost of the investment; this makes it difficult for trustees to understand the real cost of investment to their schemes.
The introduction of MiFId II and cost disclosures has encouraged greater disclosures by fund managers around the true costs of pension scheme investments. Industry bodies, such as the Pensions and Lifetime Savings Association (PLSA), have introduced voluntary cost disclosures that have gained traction and are being used by many pension schemes.
This has enabled trustees to understand their costs in greater detail. For example, using the PLSA CTI (Cost Transparency Initiative) template means it is much easier for trustees to make comparisons of costs across different managers. In some cases, this can help drive fee negotiations leading to lower fees, which is a great result.
However, there are areas such as implicit costs which are much harder to get from fund managers, in particular for segregated portfolios. Making it easier to obtain this information would allow trustees to make more informed choices around the true cost.
Watch out for higher expenses
The increase in cost disclosures is an additional expense for fund managers. Whilst many are doing their best to provide the information, there is the possibility some costs could increase as a result of the additional reporting requirements. For example, an active manager may introduce a performance fee to make the initial cost seem lower, or they could increase the expenses elsewhere to compensate, or the additional expenses could creep higher over time as the administration costs rise.
Therefore, whilst cost transparency has helped investors understand what the true costs of an investment are and, in some cases, has resulted in savings and provides value for money, it should not be a surprise if the additional costs are ultimately passed onto investors, something trustees should look out for.