“Hidden costs” – what hidden costs?
“Hidden costs” – what hidden costs?
Here’s a new year puzzle for you. Fund A has annual charges of 1.5%, and in addition incurs annual trading costs in its portfolio of 0.2%. Fund B also has charges of 1.5% a year, but its trading costs are 0.4% a year. Which is better value for money?
There’s a group of people out there who want you to believe the answer is Fund A – after all, the costs are lower, so you must get a better return.
Now here’s another clue. Last year Fund A returned 1% less than the stock market index, while Fund B returned 1% more. In other words the extra 0.2% of trading costs resulted in a 2% extra return. In my book that would be pretty good value for money.
These are illustrative examples. It would be wrong to argue that funds with higher trading costs always perform better. But the point is that they might. And you do not know unless you look. The costs of trading the portfolio are inseparable from the impact on returns of the associated investment decisions.
The combined effect of trading decisions and their costs is reflected in a fund’s net performance, which is measured after published charges, after trading costs, and after any other effects including the bid/offer spreads on underlying investments. There is no hiding place for the fund manager from the cold facts of net performance: if he is not delivering for investors, the fund slips down the performance tables and, in the absence of improvement, is likely to lose custom to its competitors.
2012 is seeing a renewal of the misguided campaign to include trading costs in fund charges. That campaign is misguided because it would mislead investors into thinking that trading costs matter in isolation from their impact on investment returns. It also ignores the iron discipline that net performance exerts on managers.
But, I hear you say, that still doesn’t tell us what all this is costing investors. All these extras – trading costs, bid/offer spreads, stamp duty and the rest – are surely leeching money out of investors’ returns, are they not?
The answer is, no they are not. How do I know? It’s the cold light of net performance again. When I blogged on this subject before Christmas, I pointed to research we did two years ago which showed clearly that the combined effect of investment decisions and trading costs was positive rather than negative for investors. We have now done some further analysis to take account of performance to the end of 2011.
And guess what? The result is the same. For both index trackers and active funds, the ten year performance showed no sign whatsoever of so-called “hidden costs” pulling down performance. For the record, FTSE all-share trackers returned an average 3.9% a year, the difference of 0.8% a year from the return on the index being exactly in line with average charges. And the active funds returned on average just over 4% a year, or 0.6% below the market – in fact recouping a significant amount of their typical charges of 1.5% or so.
These are the facts. I’d like to think we will hear nothing more about “hidden costs” to investors, though I suspect I am going to be disappointed. But we at the IMA will aim at least to keep the debate informed with the true facts.
Richard Saunders
Chief Executive, IMA
27 January 2012
Richard Saunders
Chief Executive, IMA