The Annual Management Charge: Only Part of the Picture
For years, the default measure for assessing a fund’s annual operating expenses in the UK was the annual management charge, or AMC. This is still the only figure shown on many-- and perhaps most--fund fact sheets in the UK. It is typically 1.50% for long-only domestic equity funds meant for in
dividual investors.
The UCITS Total Expense Ratio: A Clearly Better Measure
In contrast to the AMC, the total expense ratio as mandated by UCITS and implemented in the annexes to the FSA's Collective Investment Schemes Sourcebook (COLL) that will take effect on 1 November (see p.18 for the TER calculation), is a much more complete measure of ongoing costs. (Note: this is not the same as the Fitzrovia TER, which we do not believe to be as accurate an indicator of fund costs; more on that below.) The Total Expense Ratio includes not just the AMC, but also any additional marketing costs, performance fees, administration fees, legal fees, etc. In short, it includes nearly all costs with two notable exceptions: brokerage commissions paid by the fund to execute transactions in the securities it holds (they are simply capitalised into the value of securities held), and borrowing costs. We’ll write more about these exclusions in our next column, but the TER is still vastly more inclusive than the AMC.
The Funds-of-Funds Issue
When it comes to costs, funds-of-funds are different from most other fund types. Effectively, they have two layers of ongoing costs: The fees levied by the funds they own in their portfolios, and the fees charged by the manager to operate the funds-of-funds. Any measure of fund costs that is making an attempt at accuracy will include both layers of these costs. Fortunately, the calculation used by UCITS funds in the UK also includes the costs of the underlying funds held by funds-of-funds. This can make a very large difference. The Fitzrovia TERs (the ones displayed on the IMA’s Web site) do not include the costs of the underlying offerings, and thus understate the true ongoing costs of many funds-of-funds to a large degree.
Why You Should Care: Real World Examples
To see the importance of using a fund’s TER instead of its AMC, let’s take a closer look at the stated figures for several UK funds. Jupiter Income’s fact sheet, for example, lists an annual charge of 1.50% and does not disclose the fund’s TER. Rensburg UK Select Growth’s fact sheet shows exactly the same AMC of 1.50% and again, does not disclose a TER. This level of disclosure is not unique to Jupiter or Rensburg (I have selected them more or less at random), and is relatively standard in the UK. The problem is that the standard is flawed.
To see why, note that, based on the above information, one would believe the two funds’ annual costs to be exactly the same. Both fact sheets say the funds’ annual charges are 1.50%. A quick look at the simplified prospectuses for these funds tells a very different story, however. The TER for Jupiter Income is 1.71%, 21 basis points per year higher than the AMC. The Rensburg offering, in contrast, levies a TER of just 1.53%. Thus, despite the identical fact sheets, investors are paying .18% per year more for the Jupiter offering. Over a short period, this is a small difference, but if you routinely pay this much more over the course of a long-holding period (as many will if they are saving for retirement), it can add up to thousands of pounds.
On the funds-of-funds front, the difference is even starker. Take New Star American Portfolio as an example. Like most funds in the UK, its fact sheet lists only the AMC under annual charges, which in this case is 1.50%. The Fitzrovia TER listed for the fund on the IMA’s web site is 1.26% (an oddity unto itself as the AMC is 1.50%). But don’t forget: The TER displayed by the IMA omits the costs of the underlying funds held by the fund. If one looks at the UCITS TER given in New Star American Portfolio’s simplified prospectus—which does include the fees of the underlying funds—it clocks in at a much higher 2.79%. In other words, the fund’s ongoing costs of operating is more than twice as much as the TER quoted on the IMA’s web site, and nearly 90% higher than its stated AMC.
Sadly, funds that do not wish to sell to investors in other EU countries can opt for non-UCITS-retail-scheme (NURS) status, which frees them from UCITS reporting requirements, eliminating the need for them to publish TERs. Many funds-of-funds elect NURS status, leaving investors unable to make an informed decision when it comes to assessing costs. We think the FSA need to revisit this issue and the disclosure of fees in general. A great deal of investor education is needed now that people are more responsible than ever for funding their own retirements, and issues like this needlessly complicate things. Our experience suggests that for investors to use information well, several standards must be met: The information must be easy to understand; it must be regularly disclosed in readily available documents; and it must be standardised in its presentation, both in terms of its format, and its position within a large document. For example, having a table that clearly specifies the TER of every applicable fund printed on the same page of every simplified prospectus or key features document would make it very easy for investors to accurately gauge the ongoing costs of funds in which they are considering investing.
Key Points for Fund Investors
For now, however, fund investors need to keep several points clearly in mind when evaluating a fund’s annual operating costs: (1) Annual Management Charges generally understate the operating cost of a fund, often significantly, (2) Total Expense Ratios—which can be found in that simplified prospectus of most funds--give a more complete picture of operating costs, and as such are a much better measure, and (3) Not all TER’s are created equal: If you are buying a fund-of-funds, be sure that the TER is accounting for the costs of the underlying offerings. TERs quoted on the IMA’s web site do not currently meet this last criteria and should not be used to judge the cost of funds-of-funds.
