1. Who is paid by collective investment schemes and how much?
Investors like to know:
1. Who is being paid what out of fund assets?
2. What are these payment for?
3. What are they called?
1) is clear. 2) is less clear. There is administration, operating expenses, dealing, research, custody, and so on. 3) is quite confusing. On the website of the FSA under "charges" I have so far come across: charges and adjustments, capital charge, charges and commission, charges and costs, charges and expenses, charges and fees, commission and charges, contract charge, costs and charges, establishment charge, entry charge, exit charge, expenses and charges, fees and charges, fund management charge, handling charge, hidden charge, initial charge, investment charge, management charge, monthly policy charge, periodic charge, preliminary charge, product charge, redemption charge, service charge, surrender charge, transfer charge, withdrawal charge. Then after "charges", there are "fees", "levies", "adjustments", "reductions", "costs" and so on.
There are also definitions to cope with, such as: What is a transaction cost? Does this include custody fees? What are operating expenses? What is the difference between the TER and the RIY?
CIS investors need to know in the first instance who is being paid what out of the assets of the scheme. Why they are paid these amounts comes second.
What is the total amount paid in commission to stockbrokers by the funds of CIS schemes? It is clear that this is considerable. For example, OXERA say that the total stockbroker revenue from commissions was £5.7 billion in 2000, and increasing 18% annually. (paragraph 103 x ). So perhaps it has now reached £10 billion annually! But it is not given in the accounts of UK-based unit trusts and OEICS - at least I have never seen it. The UCITS Directive says the Simplified Prospectus must contain:
" 2.2.1 (d) an indication of all the other costs not included in the TER, including disclosure of transaction costs when these are deemed to be available by the home Member State competent authorities;" x
In Appendix 1 of the FSA report Implementation of the Simplified Prospectus requirements in the UCITS Management Company Directive (2005, Policy Statement 05/4 x), the "Contents of Simplified Prospectus" (under COB 6) says that it must give:
"(14) (a) (iv) an indication of all the other costs not involved in the TER, including transaction costs".
This is the same as the above except "disclosure of" is missing. "An indication of" seems vague. It seems to mean "indication of the existence of", without saying how large they are, because I have not found any quantification in accounts, also:
"14 (a) (ii) on an ex ante basis, disclosure of the expected cost structure, that is an indication of all costs available according to the list set forth in COB 6 Annex 2 so as to provide investors so far as possible, with a reasonable estimate of expected costs."
"Disclosure of the expected cost structure, that is an indication of all the costs available" is surely not "a reasonable estimate of expected costs", unless information is provided about what these costs have been in the past. The FSA says in COB 6, Annex 2, defining transaction costs:
"2. (c) They include brokerage fees, taxes and linked charges and the market impact of the transaction taking into account the remuneration of the broker and the liquidity of the liquidity of the concerned assets." x
"Soft commissions" are apparently included by the FSA under "brokerage fees" rather than "operating costs".
"Deemed to be available by the home Member State competent authorities", in the Directive seems like a let-out, so that authorities do not have to oblige UCITS-approved funds to disclose transaction costs if they do not want to. In CIS accounts it should always be clear who is being paid what out of CIS assets.
Fitzrovia says in the 2002 edition of their report Portfolio Turnover of UK Funds:
"Transaction costs in the UK are currently 'hidden' and the issue needs to be raised so that it can be addressed and, potentially, so costs can come under greater control." (page 232)
"Even for a company that specialises in investment research, it is currently difficult to analyse the trading costs without having disclosure guidelines in place." (page 228)
The Green Paper says:
"The Commission will push for further progess in crucial areas, such as the disclosure of fees and charges." (page 4)
A common sense general approach to this topic is: Who is paid by the scheme and how much?
2. "Fee-sharing agreements and soft commissions"
The Simplified Prospectus has to contain according to UCITS:
"2.2.1 (f) An indication of the existence of fee-sharing agreements and soft commissions" x
Here we have "an indication of the existence of" rather than just the "indication of" for costs outside the TER. "Fee-sharing agreements" includes:
"2.2.2.1 (a) fee-sharing agreements on transaction costs between a UCITS' management company and a broker whereby the broker agrees to split with the management company the transactions fees paid by the UCITS to the broker for processing transactions for the UCITS;"
"An indication of costs" referring only to whether or not they exists, does not seem correct because costs can be quantified. If costs are indicated and then not quantified this means they are half-hidden: "You are paying these costs, but we are not telling you how much they are."
The Consultation Paper of the FSA Bundled brokerage and soft commission arrangements for retail investment funds (2005) x does not mention "fee-sharing agreement", or "commission recapture" which is apparently the same. The IMA says:
"Commission recapture can be directly contrary to the fund managers duty to provide best execution for his client by forcing him to transact through different brokers at a higher cost than would otherwise be the case." x
"A client with such a third party directed commission program is gaining the benefits of additional brokerage services but is being allowed to opt out of paying for them." x
A stockbroker in the US says:
"The recaptured commissions can be deposited back into the fund or the fund can instruct the brokerage firm to pay certain administrative expenses on behalf of the fund." x
There seem to be three possibilities for what happens to recaptured commissions.
1. they go back into the fund,
2. they pay administrative expenses of the fund,
3. they go to the fund management company.
In the case of UCITS funds, the FSA says that the second option applies, since in Contents of Simplified Prospectus, referred to above, it defines "fee-sharing agreements":
"(14) (b) (i) .. Those agreements whereby a party remunerated either directly or indirectly out of the assets of a scheme agrees to split its remuneration with another party and which results in the other party meeting expenses through its fee-sharing agreement that should normally be met, either directly or indirectly, out of the assets of the scheme."
Commission recapture reduces the TER, even though investors do not pay less. How can we know what is happening when payments to stockbrokers is not given in accounts?
Recommendation 1: UCITS Directives should require CIS accounts to specify the total amounts paid to stockbrokers, and the proportion which is for dealing.
3. Portfolio turnover
The definition of "portfolio turnover rate" (PTR) in the UCITS Directive is unsatisfactory. In the case of a unit trust, the PTR compares the dealing in the shares held by the trust with the dealing in the units of the trust. Let S be the total of all purchases of shares plus the total of all sales of shares, and U be the same for units during a year.
PTR % = 100 x (S - U) / (average assets during the year)
Purchases and sales of units are called "subscriptions" and "redemptions".
The PTR should be negative. If it is positive, it follows that they are investing short-term and we are investing long-term. The standard definition used by Fitzrovia x and mutual funds in the US is:
portfolio turnover = minimum of total sales and total purchases
of shares held by the fund / average assets during the year
The portfolio turnover of UK-based unit trusts and open-ended investment companies in the UK are given in reports Portfolio Turnover of UK Funds from Fitzrovia published in 2002 and 2003.
For UK investors the next step after the disclosure of portfolio turnover seems to be the disclosure of stockbrokers' commission, followed by the disclosure of stamp duty, which is a further topic and is not discussed in this submission.
Recommendation 2: The UCITS definition of PTR should be changed to be the conventional US definition of portfolio turnover.
* Member of:
Equitable Members Action Group, x
Investors Association,
x
United Kingdom Shareholders Association.
x
Website: www.comparativetables.com,
e-mail: centre@boltblue.com.
14th July 2005