Peter Robertson, head of retail at Vanguard Investments UK, comments:
“In the UK, the term Total Expense Ratio (TER) was supposed to have replaced the Annual Management Charge (AMC) and we ought to be well on the way to having all inclusive prices for investment products. This is clearly not the case.
“While, TER appears where it is officially supposed to, AMC remains the lingua franca, and more problematic still the ‘T’ in TER is a total misnomer because transaction costs (including tax) are so high that what investors actually pay can be very different to the TER.
“There is nothing technical about the first part of this problem. As with any name change TER has to fight for recognition. When the old version is easy to remember and left in a prominent position the challenge becomes almost insurmountable. At present, TERs are confined to disclosure documentation and research papers while the AMC is still what people look for.
“The second challenge is more technical in nature. Regulators and industry practitioners agree that a refined TER is the way forward in terms of disclosing costs. They also agree that the TER should exclude transaction costs. At first sight that seems odd: how can it be a ‘total’ if something is excluded. The argument for exclusion is that the TER is about operating costs, while transaction costs are capital costs and so will show up in the investment return.
“However, in some EU member countries transaction costs are currently included in operating costs (1) and European regulators insist managers disclose their portfolio turnover rate (PTR). If you know the average transaction cost and multiply it by the turnover rate you can easily calculate a revised TER and this is the direction in which we should be heading.
“Turnover is a bigger issue in the UK, specifically in UK equity funds, than anywhere else in the developed world because of Stamp Duty Reserve Tax (SDRT). Increasingly, transaction costs such as broker commission and spreads are usually very low, sometimes just a few basis points, so SDRT at 0.5%, is the majority of the transaction cost.
“Lipper produce an annual study on UK fund PTRs, using a definition that directly relates to manager driven turnover, and recently that has been in the 55% to 60% (2) range. With SDRT at 0.5% this means UK equity funds incur nearly 30bps of stamp duty every year. The 1.5% ‘standard’ AMC for UK All Companies funds which becomes an average TER of 1.58% (3) leading to a cost of perhaps 1.9% each year when all average turnover costs are included.
“At one extreme a low cost fund tracking the FTSE All Share should have very low turnover, well below 10% per annum, and a combined cost of perhaps 0.2% pa. In contrast, some active funds have PTRs in excess of 300%, leading to clients paying 1.5% in SDRT each year and resulting in a total cost of 3% each year when added to the TER.
“Taking an example of an investment of £10,000 with charges of 0.2% (a low turnover tracker) or 3% (a high turnover active fund) and compounding over 10 years with 6% growth, the tracker would be worth £17,553, while the active fund would be worth £13,206.
“Making clear the relationship between turnover and cost would not only tighten up TERs but might enable investors to save some tax. We believe that AMC should be relegated to the small print and providers only advertise TERs, which should, ideally, be the real price paid by customers. We also believe that PTR should be refined to reflect manager driven turnover and thereby enable the calculation of an annual cost to the investor.
“At Vanguard we aim to ensure that the costs investors incur are both transparent and fair. We pay all running costs out of our AMC, so there are no hidden charges – therefore we expect that our AMC will be the same as our TER. We also aim to keep our running costs to a minimum. All of this helps us to be more transparent and gives our clients a better understanding of the cost of their investment.”
- Ends -
Notes to editors:
(1). Lipper views on transaction costs (response to CESR)
(2). Turnover
(3). UK All Company charges
Total Expense Ratio (TER)
According to the FSA: The TER of a simplified prospectus scheme is the ratio of the scheme's total operating costs to its average net assets. The main costs included and excluded from the TER are: - Included: Total operating costs include any legitimate expenses of the simplified prospectus scheme, such as: management costs including performance fees; depositary fees; audit, legal and regulatory fees; any additional management fees. - Excluded: Transaction costs, including brokerage fees, taxes and linked charges.
The TER is calculated at least once a year. The average net assets must be calculated using figures that are based on the scheme's net assets values, e.g. daily NAVs.
Portfolio Turnover Rate (PTR)
The FSA (and European) definition of the Portfolio Turnover Rate is:
Turnover = ((Purchases + Sales) – (Subscriptions + Redemptions)) / Average of total net assets
This definition means if a fund turns over its whole portfolio once in the year the answer is 200% (rather than 100%, as one might expect) while we know of at least one instance where it has produced a negative number for a live fund.
The Lipper survey results use a different, more intuitive, method which defines turnover as the lesser of purchases and sales divided by the net assets. Using this definition turning over the portfolio once in a year gives a PTR of 100% and no fund will have a negative PTR.
SDRT is payable on the purchase of the underlying UK equities or their transfer and while neither calculation gives you a perfect indicator of the SDRT cost to the fund the Lipper rate is much closer than the FSA definition.
