Hidden fund fees: The Loch Ness Monster of investments?
Equity fund returns are 0.71% above index returns per annum, higher than the -1.59% underperformance expected based on charges and transaction costs, suggesting there are not hidden fees in funds
The average portfolio turnover rate in equity funds is 40%, which also brings the hidden-fees hysteria, and claims of fund manager overtrading, into doubt
Our forthcoming Disclosure Code will standardise fee disclosure including implicit cost estimates across all investment products
The Investment Association has today published research calling into question claims there are hidden fees lurking in funds that can cost investors several times as much as headline figures.
The industry takes such claims seriously, but it has also long noted the critics state that hidden fees lie within but fail to identify conclusive signs of their existence.
Our research represents a significant investigation into the impact of fees on investment outcomes including analysis of the accounts of hundreds of equity funds using the data archives of Fitz Partners.
The report finds zero evidence that funds' returns are affected by hidden fees lurking within, suggesting that 'hidden fund fees' may in reality be the 'Loch Ness Monster of investments'.
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The research first assembles the most accurate average figure to date of all fees and charges
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These are then subtracted from benchmark index returns to establish the post-fee returns one would expect from funds
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Our expected returns are then finally compared with the actual average net returns seen from funds across numerous sectors
Fees and charges research
Funds' fees and charges ranging from asset management charges to portfolio costs are reported widely in the European OCF measure of fund costs. Our research focuses on funds' pre-RDR share classes, which include bundled adviser and platform fees, owing to easier availability of data at the time of the research.
In addition, costs for carrying out transactions on the markets, such as commissions and stamp duty, are published annually in funds' annual reports. By analysing the 1,350 fund annual accounts hosted on Fitz Partners' database, we have been able to estimate average transaction fees across our fund sectors.
Our costs and charges findings:
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Funds' average bundled Ongoing Charges Figure (OCF) fees were 1.42%
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Funds' average transaction costs were 0.17%
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Combining the two suggests average bundled equity fund costs and charges of 1.59%
There can also be notional costs of doing business on investment markets inherent in funds' securities buying and selling prices. Known as 'implicit costs', these exist for example in the bid-offer spread offered by a broker for trading a security.
Some say implicit costs, which can only be estimated, constitute a 'hidden fee' that adds up to multiples of the fees and charges in funds. Implicit costs are not estimated as part of our expected shortfall, but they are included in the net return figures in our analysis.
Comparing the returns you would expect funds to deliver, taking into account their costs and charges, against actual net returns should expose evidence of any such 'hidden fees'.
What were the results?
Funds in fact outperformed their expected net performance versus markets of -1.59% overall, suggesting the hidden fee claims are misplaced. Not only that, funds on average performed better than markets they invest in by 0.71% on an annualised basis.
In addition, the asset-weighted average portfolio turnover rate across all equity funds is 40% - too low to lead to the malign levels of 'hidden costs' claimed by the critics.
Investors must have full confidence that they are aware of potential investing costs as well as fees and charges, and so the Investment Association is working to deliver better indicators of implicit costs across all investments.
The Investment Association is set to launch a public consultation later this year on the delivery of a new Disclosure Code to achieve fully standardised reporting both of fees and charges and implicit costs.
Today's research follows the recent publication of a report by Oxera which found that for an investor with £10,000 it can cost more than seven times as much to invest in the stockmarket on your own rather than using a pooled fund structure.
Jonathan Lipkin, Director of Public Policy at the Investment Association, said:
"The industry should be judged on its actual delivery, not on perceptions of delivery. Our research with Fitz Partners is a detailed empirical analysis of equity fund performance in the context of quantified charges and costs.
"If you look at the actual performance delivered to fund investors, this is the proof point and we do not see evidence of high transaction costs, either explicit or implicit."
Hugues Gillibert, founder of Fitz Partners, said:
"I am extremely pleased with our cooperation with the IA in the building of this thorough analysis of funds costs and performance. This research paper is long overdue and I trust it will be welcome by all stakeholders: investors, fund distributors, asset managers and also industry commentators.
"This research makes no judgement as to what could be considered the right level of fund fees or what could be qualified as cheap or expensive, but by taking into account all costs borne by the funds and in turn by the investors and its potential impact on funds returns, it measures the actual value added by performing asset managers and the unlikely presence of significant transaction costs."
