Significant disclosure 'still lacking'
Investors and advisers are still being kept in the dark about significant components of fund managers’ fees, it has been claimed.
Tuesday, September 27th 2016, 6:00AM 
4 Comments
by Susan Edmunds
Managers are transitioning to the new Financial Markets Conduct and the FMA released a guidance note in May on how they should manage their fee disclosure requirements.
But adviser Brent Sheather said despite the move to a new, standardised product disclosure statement, which includes more explicit detail about typical fees charged to investors, there were still significant costs not being disclosed.
He said a key one was the brokerage fee paid to stockbrokers to trade portfolios
“It is standard practice in NZ and overseas to leave these costs out when calculating the fee structure of the fund. Furthermore some fund managers include these costs when producing the Statement of Comprehensive Income and others don't,” he said.
“One fund manager disclosed in the Statement of Comprehensive Income, which no one reads, that the brokerage charges paid to stockbrokers were $3million in 2016 which is material in the context of a $300 million fund. These charges however were omitted from the expense ratio calculated in the investment statement which the regulators tell us is the "go to" document for full disclosure.”
John Berry, of Pathfinder Asset Management, said in some cases high-turnover funds would have annual brokerage fees as high as the management fee. “This is a real cost for investors and something I would expect investors would want to know. Rates for brokerage are not standard. We use the most efficient offshore brokerage solutions we can find - our brokerage can be less than 0.03% where a local broker may charge us up to 10 times that amount. By not being required to disclose trading costs. investors get no feel for how efficiently a fund manager runs the fund.”
But he said investors sometimes paid a “spread” to cover the costs of brokerage.
“If an investor comes into our Global Property Fund the entry price is NAV plus 0.05%. The extra 0.05% is to cover brokerage expected to be incurred for trades relating to that investor. They cover the cost of them joining the fund - therefore that brokerage expense should not need to be disclosed - it is not a cost shared across all investors in the fund. But if the fund does not charge a bid/offer spread then the brokerage is a real cost shared by all investors.”
George Carter, of Nikko, said there were reasons not to disclose.
“Brokerage isn’t a cost that is incurred as a result of investing in a fund as opposed to investing directly. So, costs such as trustee fees, unit registry, and fund accounting are all expenses that you wouldn’t incur if you went to a broker and bought/sold securities directly; but you would still be subject to brokerage fees, and often higher for individuals that what institutions can negotiate,” he said.
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Your approach of throwing mud at any fund manager in sight is not a fair one. Here’s my view on disclosure of fund brokerage:
(1) Brokerage is a real cost for investors and something I would expect investors would want to know (read the article, I say this!). In our Securities Act offer document (Prospectus) we included our brokerage costs in fund fee disclosure. Our 2013 submission to MBIE / FMA on the FMC Regs said “Pathfinder disagrees that brokerage charges and other costs of buying and selling investments should be excluded from total fee calculations…..” and went on to explain why fund managers should be required to disclose brokerage.
(2) When an investor enters (or leaves) a fund they often pay a spread. If a manager is disclosing fund brokerage, then that spread amount should probably be taken off the brokerage charge. This is because the brokerage has been paid by that specific investor and not shared across everyone in the fund. Why do you think that is contentious?
You’re a bit wide of the mark on this one.
Regards
John
Just to put some flesh on the bones, as an example of fund manager behaviour that differs from your world view, here is the total brokerage paid in one of our equity funds over the last 12 months to 31 August, and the percentage of the average fund size that corresponds to:
Global Water Fund
Total brokerage/commission: $7,037.38
Average fund size: 8.38mm
Brokerage %: 0.084%, i.e., 8.4 bps
Note that that brokerage includes that in respect of new money (which incurs a 5bp spread to equalise the costs between new and exiting investors).
All our funds incur similar or lower brokerage.
This definition is reflected in concepts like ‘Management Expense Ratio’ (MER), and more recently the ‘Synthetic Total Expense Ratio’ (TER) defined in section 24 of the KiwiSaver (Periodic Disclosure) Regulations 2013.
Brokerage when securities are bought and sold falls outside this definition. The truth is, smaller direct investors typically face higher brokerage costs than they would if they invested in a fund the bought and sold the same assets. Other assets funds can invest in, such wholesale funds, can be difficult or impossible for smaller individual investors to access.
Fund management costs are a significant consideration for prospective investors weighing up their options. This makes their clear, concise and effective disclosure an important consumer protection.
I am no advocate for the managed fund industry, but fund costs do need to be offset against benefits like lower brokerage, and access to wholesale markets. Fund managers can use sophisticated tools and strategies that smaller investors often can’t: such as managing currency risks, and using futures and options to buy ‘downside protection’ at times of high volatility.
And we shouldn’t forget the ‘convenience factor’. Fund investors often avoid complex accounting and tax costs; and the time, effort and advice required to deal with a procession of corporate action options. And fund investors can usually access valuation and other fund details with just a few clicks over a morning coffee.
Like advisers – another cost to weigh up – funds can have their place.
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Similarly Mr Carter says “there were reasons not to disclose” but he neglects to mention the main reason which is of course to promote as low an expense ratio as possible. I also found his last paragraph a bit humorous because he seems to be arguing that you don’t need to disclose brokerage because you would incur brokerage if you were investing directly. This is like VW saying the running costs of our cars are minimal by omitting petrol costs on the basis that owning some other type of vehicle would also incur petrol costs.
Investors want to know and should be told what they are paying.
Mr Carter also conveniently forgets to say that fund managers typically trade far more excessively than your average retail investor let alone index funds. What is also missing from the discussion is an estimation of the all up costs of dealing including bid/offer spreads. A UK study, some years ago, estimated that as being around 1% pa for the average managed fund, i.e. a material cost.
Regards
Brent Sheather