New costs and charges information for investors

New costs and charges information for investors

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One of the changes brought in by new European regulations at the start of 2018, known catchily as MiFID II, was a requirement for investment firms to provide clearer information about costs and charges. This comes in two forms. The first is a statement before an account is opened, which sets out the expected costs, both one-off and annual. In the interests of clarity, they distinguish between costs incurred at portfolio level, such as for portfolio management and custody, and those which apply to the underlying investments.

Since it is issued before any money has been invested, clearly this requires an amount of educated guesswork as to how the portfolio will be invested and the frequency and volume of trading that will take place each year. As well as the portfolio costs, those of the underlying assets also need to be estimated.

The latter apply only where pooled funds such as unit trusts, open-ended investment companies (OEICs) or investment companies are held. They include any initial fund charges, fund annual management costs and the costs of trading within those funds. Of necessity, since the latter can only be determined from a fund’s annual accounts which are published once a year, they are historic and may not reflect the reality of the investor’s first year, which is obviously in the future.

Determining what the next year’s costs are likely to be based on certain assumptions is relatively straightforward, particularly for a model portfolio whose composition changes infrequently. Its costs can be estimated fairly accurately and the more forward-looking forms have been doing this for some years before it became a requirement. Indeed, such firms welcome, as do we, the introduction of such a requirement as it is now considerably easier for us to obtain cost details for the other assets in a client’s portfolio than it was previously.

Providing this information prior to the investment being made became a requirement from the start of 2018 so by now anyone investing new money since then will have received one.

However, in a laudable effort to ensure that investors are not misled, whether inadvertently or not, by inaccuracies in the pre-investment costs document, the same regulations also introduced a requirement to provide a statement at least once a year which shows the actual charges that they paid. The first must have been sent by the end of April 2019 so if you have any investments and have not yet received one, you will soon. There is the option to send them more frequently but for the reasons noted above, the data is unlikely to change much within a year so it is unlikely that most firms will do so.

These are produced by what the regulations refer to as ‘distributors’ – in the real world these are the firms which work directly with investors, such as planners, advisers, and private client investment managers. Of course, the regulations do not prescribe a format for these so there are different layouts used by each firm. Nevertheless, there will be some similarities between issuers and that should help to make them comparable with each other.

Conceptually the (simplified) model below covers the main aspects for a portfolio comprising two accounts:

Source: Bloomsbury Wealth

There are several key elements to understand:

Direct costs and charges paid to the firm with which you have engaged. These are split between:

  1. One-off costs (those paid on new money added to the portfolio);
  2. Ongoing costs (such as management fees and custody costs);
  3. Transaction costs (incurred when trades take place within the portfolio);
  4. Incidental costs (covering such ancillaries as bank transfers, additional valuations and the like) and
  5. Taxation (typically stamp duty, which is payable on share purchases and VAT, payable on some fees).

Indirect costs and charges attributable to the underlying assets in the portfolio. If you hold pooled investment funds, these costs will again be split, between:

  1. One-off costs (those paid on new money added to a fund);
  2. Ongoing costs (such as management fees and other recurring costs incurred by the funds);
  3. Transaction costs (incurred when trades take place within the underlying funds) and
  4. Incidental costs (these are typically performance fees if you own a fund which charges them).

Not every item on this list will have a cost associated with it. For example, if your portfolio only contains directly held assets such as shares or fixed interest securities, the second section is likely to be blank. Similarly, if your portfolio manager absorbs the costs of transactions itself, the transaction costs of the first part will be blank.

All these costs are expressed in cash terms as research has regularly found that many people have difficulty interpreting percentages. It is clearly tempting to suggest that this is why financial institutions like them so much. However, in reality percentages are a better tool for making some comparisons (not least because that is the basis on which charges are published on fund managers’ websites) but for now, cash figures are what will be shown on investor statements.

In most instances, the cost that matter (as they have the greatest impact over time) are the ongoing and transaction costs, both in the first and second sections. One-off costs (obviously) arise only once and in recent years have become much less common than they once were.

The new regime is not perfect. The regulations, astonishingly, do not prescribe a methodology for calculating the cost of transactions within a fund, so providers can use a variety of ways to come up with a number. The method selected can result in different results so unsurprisingly, this can make valid comparison between two providers tricky at best. Those who are most diligent in identifying and disclosing costs could be at a disadvantage to those who are less stringent.

Since pensions and insurance products are covered by different regulations, the consolidated statement will only include funds invested via such wrappers if they are invested in assets which are not specifically pension or insurance funds. However, if you happen to own ordinary funds (or individual shares or fixed interest investments) within a self-invested personal pension (SIPP) or personalised investment bond wrapper, then those will be included. However, the costs of the wrapper itself will not. Managers of products based outside the European Economic Area (EEA) are not obliged to provide the data needed to satisfy the regulations but firms using them are obliged to obtain it. Potentially this could require moving a client to a more expensive product just to satisfy the rules. Fees paid for services such as financial planning that are not specifically linked to portfolio value are also excluded.

There is also the point that while people might struggle to understand percentages, grasping the significance of yet another document full of numbers which happen to be in cash terms when investors are already bombarded with paper that many do not read may not help too much with clarity. Some graphics might help. Inevitably a document which only describes costs does not make any reference to value to place them in context so this is down to the issuer to address.

One aspect (apart from the sheer workload involved) which might give rise to some concern on the part of managers, given that 2018 is the first year for which the new requirement has applied, is that over the year most portfolios will have fallen in value even before costs. Investors will see what they paid in a year when they lost money and may therefore question, if what they were promised was an ability to predict market movements, whether they received good value for this.

Nevertheless, despite the flaws, this is a significant step forward and it is likely that the content will evolve over time to become more useful. One thing that might happen is the application of pressure to expensive providers to reduce costs where an almost identical product is available for less cost; indeed one such instance was reported recently . This has to be a good thing and it should also make it easier for both advisers and investors to identify the true costs of their portfolios which have, in many cases, been opaque for years.