Fund Fees Must Be More Transparent, says The IA

Fund fees have fallen in both the active and passive market in recent years, but the industry must be more transparent when it comes to cost says The Investment Association

Emma Wall 19 May, 2017 | 9:22AM
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Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and I'm joined today by the IA's Dr. Jonathan Lipkin to talk about fund fees.

Hello Jonathan.

Dr. Jonathan Lipkin: Hi.

Wall: So, I thought I'd start by setting the scene and that is over the last couple of years it has been quite positive for investors and that fund fees have come down because of regulation, haven’t they?

Lipkin: Yeah, we've seen falls in fee rates both in the active and passive market and we see a very competitive market emerging, but we've also been clear that we think there is more to do in the context of disclosure, both at the fees and costs. And we also agree with the FCA that there needs to be a little bit more work done on the clarity of objectives and some of the reporting against delivery of those objectives.

Wall: And I think that transparency is key, because fund fees have come down, great news for the investor. But I think a lot of retail investors are still confused about what goes into that fee, what makes up that fee, where their money is going? And I think there is some move in the future coming through which will help with that, isn’t there?

Lipkin: We want there to be complete clarity and we want there to be consistency around two key points. Firstly, to be able to say what am I charging you as a fund manager and if the investor asks what am I paying for the service that is fund management, to be able to answer that very clearly. But also for there to be accountability if the costs are incurred in investing the money. So, to be clear if you come as a retail investor and you invest in a fund.

You are paying somebody to do the job that you could try to do yourself, but you decided to entrust that money to a professional. And that professional will also incur transaction costs that you would have incurred had you tried to do it yourself and it's important that you have accountability for both of those. So that you can understand both the performance, the associated transaction cost of getting that performance and what you have paid a professional whether it's passive or active to deliver you an investment return in a given market over a given time.

Wall: And I think that’s really important that breakdown. Because different fund managers operate in different ways. Some will have higher transaction costs because that is the way they run their fund. They have a higher turnover but that results in a higher performance and others will be sort of the individuals that sit and hold.

But without that information that you described, it's difficult for investors to compare and contrast when making an investment decision. So, without that information they can't make the best investment decision for themselves can they?

Lipkin: And we put forward a framework now that would ensure that there is a consistent definition of portfolio turnover rate, so you can understand how a fund manager behavior may have varied from year-to-year. As well as understanding the transaction costs that are inherent in delivering return. You made the point very well there is no inherent connection between transaction costs and investment performance.

You need to be able to explain your investment performance and the associated transaction cost. And fees behave in a very different way. The higher the fee the lower the investment return. Transaction costs do not behave in that way. There is no linear connection between the way that you invest and the return that is delivered. And I think the danger is that if you take those two pieces of information and charges in the transaction costs and put them together in a single number. It may be harder to understand.

You certainly get the full economic experience of your money, but I think we need to have both of those pieces of information available. So just to be very clear you should have total transparency but we need to be mindful of how people might wish to use that information.

Wall: And what's the timeline for this when can we expect to have this information in our hands?

Lipkin: Well, the European regulators are driving the timeline. And so MiFID II and the new PRIPs, the key information document that will be on the European regulatory frontline will be the beginning of 2018. There is new pension scheme reporting coming in the U.K. for defined contribution pension schemes. And if you put all of that together you'll see a real paradigm shift over the next year. The IA code which is intended to try and offer a consistent way through that we hope will be completed in the summer of this year, but that is all subject to regulatory approval particularly the outcome of the market study.

Wall: So watch this space.

Lipkin: Watch this space.

Wall: Jonathan thank you very much.

Lipkin: Pleasure.

Wall: This is Emma Wall for Morningstar. Thank you for watching. 

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Emma Wall  is former Senior International Editor for Morningstar

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