Since I started to invest, fund charges have generally headed in a southerly direction. Thanks to the popularity of index funds, Vanguard and the late, great John Bogle, more of my returns are finding their way into my pocket rather than someone else’s.
But what is a reasonable charge to pay for an investment trust these days? How easy is it to tell if you’re paying a fair amount or getting stitched up like the proverbial kipper?
Paying up for performance
It’s an area I’ve struggled with for a while. What’s more, the information isn’t always easy to get hold of and its presentation can be inconsistent.
In principle, I’m happy to pay a little more for good performance. I’m aiming to beat the market after all, and that isn’t easy.
But I’m very aware that despite the downward pressure on fund charges over the last few decades, the profit margins that fund managers enjoy are still pretty plump.
Here’s a selection of listed fund managers and platform operators and their operating profit margins:
- Schroders: 37%
- Jupiter: 42%
- Janus Henderson: 25%
- Aberdeen Asset Management: 36% (before its merger with Standard Life)
- Hargreaves Lansdown: 65% (not a typo)
- AJ Bell: 32%
A lot of investment trust managers are part of larger groups (e.g. JPMorgan) or are partnerships (such as Baillie Gifford, the manager of Scottish Mortgage, and Fundsmith) making it harder to see the full extent of their profit margins.
For example, the latest accounts for Baillie Gifford & Co Limited show its profit margins to be just 7%, but the main partnership sits above this company and it owns four other subsidiaries as well.
Overall, it’s pretty clear the financial services industry remains a highly profitable one.
Twice the pain
As investors, we often pay twice. We pay for the actual management of our investments and then we may also pay administration costs to a platform depending on how we invest.
If you’re not careful it’s easy to pay 1.5% to 2.0% for a pretty mainstream fund. In a low-return world, where returns might be 8% (for the sake of simple sums) then that’s a quarter of your returns vanishing straight away.
When you consider the effect of compounding, it’s even worse:
- 6% compounded over 30 years turns £10,000 into £57,435.
- At 8% you would have got £100,627.
Almost half your final sum has leaked away!
One of the reasons I tend to favour investment trusts is that it’s much easier to avoid the percentage fees that platforms tend to charge. It’s the other cost — that of the underlying fund — that I’m concerned with here.
The scale of the problem
One particular issue with the fund management industry is that it doesn’t cost significantly more to manage, say, £400m than £200m.
But many fund charges are set at a fixed percentage. The economies of scale go largely to the fund manager and not to investors.
Some fund charge structures have begun to reflect this, with tiered cost structures that reduce as the size of a trust grows. But the reductions often seem quite small, and only apply to assets above set levels rather than to all the funds under management.
Here’s the management fee reduction for the recently launched Mobius Investment Trust for example:
(i) 1.00% of Fund Value up to and including £500 million;
(ii) 0.85% of Fund Value over £500 million and up to and including £1 billion; and
(iii) 0.75% of Fund Value over £1 billion.
On the face on it that might seem quite a cut. But the fund only raised £100m, so it has to grow fivefold before there’s any reduction at all.
Even if the fund grew to £2bn, the percentage charged on the full amount would still be 0.84%.
What charges do we pay?
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My younger and even more naive self tended to just consider the annual management fee when comparing fund charges.
It’s usually by far and away the largest element, but there is a whole set of other fees that get included in the standard ongoing charges figure (OCF) that you most often see quoted for investment trusts:
- directors’ fees
- company secretary
- trustee/depositary fees
- registrar fees
- regulation costs
- legal and professional advisers
There’s a detailed list of what’s included and excluded in this document on the AIC website.
Take Scottish Mortgage. It charges 0.3% for assets up to £4bn and 0.25% above that level. That’s comparable with most Vanguard funds you can buy in the UK, so kudos to Baillie Gifford for that.
Based on net assets of £6.5bn, the management fee should, therefore, be 0.28%. Scottish Mortgage’s ongoing charge figure is currently 0.37%.
All the other expenses seem to add about a third to the ongoing cost figure. I think that’s fairly typical although I must admit that I haven’t looked at this in any great detail across dozens of funds.
What’s not included in the ongoing charge figure?
The ongoing charge figure is useful but it’s not the whole story. There are a number of costs that don’t get included because they aren’t considered to be ongoing. The AIC provides this nugget:
“ongoing charges are the costs that the investment company would have to pay in the absence of any purchases or sales of investments and if markets remained static through the period.”
So transaction costs of buying and selling investments within a fund (broker fees, the spread between buying and selling and stamp duty) aren’t included. And neither are performance fees. If the market is static then there’s obviously no performance to measure!
Interest costs are also excluded as they are deemed to be a capital expense rather than an operational one.
And last of all, for reasons I am not clear on at all, the cost of other funds that an investment trust invests in, don’t seem to be included either. More on this a little later.
Enter the KID
One document I’m finding very handy in the fight against fees is the Key Information Document (KID).
It’s been slagged off by most of the investment trust industry for the ‘Risk Rating’ and ‘Performance Scenarios’ sections. And I’d agree with that part of their criticism.
Having been an investor for a few decades now, I pretty much ignored those parts of the document anyway, as it was pretty obvious the information provided was pretty useless. But I can certainly understand why newer investors might be led astray.
My main interest was costs and here the KID provides additional information that is hard to get elsewhere.
In Scottish Mortgage’s case, the total costs to consider are 0.81%. These break down as transaction (0.04%), investment management (0.3%), administration (0.07%), interest (0.38%), and the costs of other funds invested in (0.02%).
Scottish Mortgage has gearing of about 10% so very roughly we could say it’s paying in the region of 4% for all its borrowings.
It seems that the way transaction costs are calculated is a little weird, in that it includes ‘slippage costs’ between a trade being placed and executed. This means that price movements in the meantime can reduce transaction costs.
Apparently, according to the AIC, this results in around a tenth of investment companies have zero or even negative transaction costs in their KIDs. I’m not entirely clear on how significant this is, but it’s worth bearing in mind that the transaction costs quoted on KIDs might be a little off.
(I dug further into KIDs in this follow-up article)
An eye-opener for me
When I was researching RIT Capital Partners for the first article I produced for this blog my monitor got covered in tea.
Its latest KID has transaction costs (0.08%), management (0.66%), interest (0.46%), underlying fund fees (1.16%, net of rebates), performance fees (1.43%), and carried interest (0.38%). Carried interest is a profit share that private equity funds charge for their ongoing management involvement in the companies they invest in.
The grand total of that little lot: 4.17%.
4.17 @?#+!*$ %
I hadn’t really appreciated how RIT had shifted away from direct investments and into funds in recent years and how much this was costing me. Now interest charges are part of the fund structure, so I’m happy to consider those separately. But even stripping those out, the annual costs are 3.7% — far more than I realised.
The KID in question is dated 31 May 2018 so I’ll be watching out for the next one to see how things have shifted.
Whenever I am looking at an investment trust these days, I’m reviewing both the standard ongoing charge information and the KID to see if there are any major differences.
Fund charges across the sectors
Although the ongoing charge figure has its limitations, it’s useful when comparing across sectors to see where we typically pay high or low charges.
Here’s some data gleaned from the AIC website. It’s on a weighted average basis, although the figures don’t seem to be provided for every single sector.
|Sector||Ongoing charge including performance fee (%)||Ongoing charge (%)||Difference|
|Global Equity Income||0.7||0.7||0%|
|Global Smaller Companies||2.0||2.0||0%|
|UK All Companies||1.0||0.7||43%|
|UK Equity Income||0.7||0.7||0%|
|UK Smaller Companies||1.2||0.8||43%|
|UK Equity & Bond Income||1.0||1.0||0%|
|N American Smaller Companies||1.4||1.1||31%|
|Asia Pacific Excl Japan||1.1||1.0||8%|
|Japanese Smaller Companies||1.0||1.0||0%|
|European Smaller Companies||1.0||1.0||6%|
|Global Emerging Markets||1.2||1.2||0%|
|Property Direct – UK||1.5||1.5||0%|
|Property Direct – Europe||8.4||4.1||107%|
|Biotechnology & Healthcare||1.5||1.2||23%|
|VCT AIM Quoted||2.2||2.2||0%|
On average, fund charges come out at 1.3%. You could say that’s 1.0% for the management fee plus a third for other expenses.
Performance fees add another 0.2%, although these gradually seem to be falling out of favour with several funds dropping them altogether as each year passes.
There certainly seem to be some sectors where performance fees are more prevalent. UK All, UK and North American Smaller, Europe and Property Direct: Europe, Infrastructure, and to the surprise of absolutely no one, Hedge Funds.
In many cases, though, it’s just one or two funds that charge fees within these sectors, rather than it being the norm for every trust. Overall, there seem to be about 50 funds out of 400 or so that still use this archaic practice.
Global funds tend to be cheapest, as they are typically the largest. The UK seems quite expensive to me by comparison I have to say.
Funds specialising in certain regions or sectors feel they can charge a little bit extra for the privilege.
Trusts that invest directly in assets that you can buy directly on the stock exchange (infrastructure, renewables, leasing etc) are also more pricey.
Some of the figures need a little examination, leasing is a good example, as there can be one or two funds (Doric Nimrod in this case) that have oddly high figures distorting the sector average.
Hedge funds and venture capital trusts tend to be the most expensive on average. The latter tend to be quite small, so there’s some logic for this. But the tax-efficient nature of these funds no doubt allows their managers to charge a little extra than they would do otherwise.
The direction of travel is good, but not the speed
I still think there’s a fair bit of room for fund charges to come down.
While there does seem to be a drip-drip of cuts being announced by individual trusts here and there, the average charges still seem quite high for an industry that has seen its assets double since the onset of the financial crisis just over a decade ago.
Admittedly, the rise of alternative funds has pushed up the average in the recent years. But these funds are often quite large and will probably have lower returns than plain equity funds over the very long term.
When I part with my earned cash, it’s important to know that the fund manager is on my side. I regard low charges as a key indicator of that.
And I still find it very disappointing that I have to hunt around for full information on costs rather than it being prominently displayed on a trust’s website or in its report and accounts.