The investment Association’s latest report suggesting that there are no hidden fund fees within the equity fund space is “not worth the paper it is printed on”, according to SCM Direct’s Gina Miller. 
The founding partner of the firm says that the research paper - which questions the belief that investors are buying funds that can cost several times as much as headline figures – is a “PR exercise” and “nonsense”.
The Investment Association’s report was released yesterday and is entitled ‘Hidden Fund Fees: The Loch Ness Monster of Investments?’.
It assembled an average figure to-date of all fees and charges, subtracted this from the benchmark index returns to determine post-fee expected returns, then compared these with the real average net returns of 1,350 funds across various IA sectors.
The trade body found that funds outperformed their expected net performance versus markets overall, which it says implies that hidden fee claims are misplaced – funds on average returned 0.71 per cent compared to an expected net loss of 1.59 per cent.
It also found that the asset-weighted average portfolio turnover rate across all equity funds is 40 per cent, which the report says is too low to lead to the high hidden cost levels claimed by critics.
“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,” the report states.
“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’.
The Investment Association will launch a public consultation this year on the use of a new Disclosure Code to achieve fully standardised reporting of fees, charges and implicit costs.
The report hasn’t put every investor’s mind at ease though.
Miller has released her own report in response entitled ‘New Name, Old Nonsense’, where she lists four reasons why she thinks investors shouldn’t pay attention to the IA’s latest findings.
“It was the IMA under Richard Saunders that produced an intellectually bankrupt and thoroughly amateurish piece of research in 2012 which we proved was totally misleading,” she wrote.
“The tone then, as now, was a PR exercise to show how wonderful the UK fund management industry is, how there is no hidden costs to speak of and how amazing all active funds are.”
“Now under new management and a new name, the IA is still producing nonsense. This research paper is not worth the paper it is printed on.”
The first reason that the founding partner of SCM Direct gives is that the transaction costs the report looks at (it found that between 2012 and 2015 these were 0.17 per cent across IA equity sectors) ignore market maker spreads.
Miller argues that transaction costs should include spreads of securities and bid/offer spread but argues that these have been ignored, are hidden from the IA’s accounts and excluded from its analysis.
“Woodford recently revealed that such spread related costs accounted for 22 per cent of the total transaction costs for his fund,” she pointed out.
“Furthermore, the analysis of transaction costs by the IA includes just a three-year period.”
She also believes that the IA has selected a “convenient” time period, given that mid-caps performed particularly strongly between 2012 and 2015 in most market conditions.
Performance of indices between 2012 and 2015
Source: FE Analytics
Given that many actively managed funds are overweight this space versus the FTSE All Share, she says that the funds were far more likely to perform well over this period as opposed to this year, which wasn’t mentioned in the report.
Thirdly, Miller says that the report claims it is a four-year analysis when it’s actually three – the IA research paper states: “We recognise that this is a relatively short-run dataset, the analysis over four years shows that on an asset-weighted basis, there is no evidence that there are significant hidden costs damaging investor outcomes.”
Miller argues that the period of analysis is, not only three rather than four years, but a short-term look at markets when investors are encouraged to adopt a longer term time horizon.
Finally, she argues that ‘survivorship bias’ is ignored, which is the concept of focusing on anything that has passed through a process while overlooking those that did not due to lack of visibility.
“Lipper recently calculated that only 52 per cent of funds available to investors in 2005 survived to the present day as they were either merged or liquidated,” she continued.
“The same must be true over a three-year period to some extent, yet neither the IA nor Fitz Partners have made any adjustment to reflect the actual returns investors received in the funds they could have invested in at the start of the period rather than those that existed at the end of the period.”
She added: “To use animal analogy, akin to the IA’s, this research shows a leopard never changes its spots. The report is amateurish and totally misleading as the IMA’s previous attempt in 2012 to somehow prove the impossible.”
“This report is not worth the paper it is printed on. The fact that the FCA has deferred its responsibility in terms of cost transparency to the conflicted amateurs at the IA is utterly shameful and should be halted immediately.”
Laith Khalaf, senior analyst at Hargreaves Lansdown, argues that the charges debate has indeed been exacerbated by baseless claims.
But, like Miller, he points out that the problem lies with transactional charges which appear in funds’ annual charges and accounts but not in the ongoing charges figures on their factsheets.
“There is a genuine question over the correct presentation of these charges, because they are variable, and so an annual calculation may give a misleading impression of regular costs to investors,” he said.
“Events like manager changes and extreme fund flows can create spikes in turnover and transaction costs, despite being non-recurring by nature. The Investment Association is consulting later this year on standardising disclose of costs.”
Khalaf points out that transaction charges are an important factor in returns but says that most fund managers are rewarded on their performance, so therefore won’t trade unless they think it will be of benefit to investors.
As such, he says that the issue is more to do with disclosure than it is misplaced incentives.
“Explicit costs are important too, and this is something we have been taking the fund management industry to task on,” he continued.
“Investors must also take performance into account when choosing a fund, in reality the dispersion of returns is much more heavily influenced by manager skills than charges.
“Over the last 10 years the best performing UK stock market fund has returned 12.7 per cent a year, the worst has returned just 1.2 per cent.”
