Fees on actively managed funds have declined in recent years as pressures from cheaper passive funds and greater regulatory scrutiny have taken their toll.

But arguably attempts by the Financial Conduct Authority to provide more transparency around fund fees has led to some confusion for investors.

In a nutshell, investors simply need to know that fund performance data is quoted after charges have been deducted, and the ongoing charges figure or OCF will tell you how much the fund will cost to own per year, albeit this number doesn’t include any charges from your ISA or SIPP (self-invested personal pension) provider.

THE BASICS OF FUND COSTS

In broad terms, fund costs can be split into two groups: those relating to investment activity (investment management fees and transaction costs) and those relating to the operations of the fund.

A manager will receive more money in fees if assets under management increase and vice-versa. It isn’t a perfect operating model but traditionally that is how most fund managers get paid. It is sometimes referred to as an ad valorem fee.

The management fee is deducted from a fund’s net asset value. Fund performance figures are quoted after management fees have been taken.

Some fund managers charge performance fees on top of the annual management fee. They are paid when a pre-specified performance hurdle is attained. Total fees are sometimes capped at a certain percentage of assets under management, also known as AUM.

A ‘high water mark’ mechanism is applied to performance fees. This requires the fund to regain any lost performance from its highest point before future performance fees are earned.

INVESTOR PROTECTION COMES AT A COST

Identifying the operational costs of running a fund requires a bit more work from investors.

Funds are required to provide investors with an ongoing charges figure which is quoted as a percentage of AUM. This captures all fees paid by the investor including the annual management fee.

Investors can quantify the ongoing operational costs of running a fund by deducting the management fee from the OCF, although this
isn’t always straightforward as many asset managers no longer publish an annual management charge figure.

Taking Fundsmith Equity Fund (FUND:B41YBW71) as an example, the OCF is 0.94%. The investment manager’s annual fee is 0.9%, so the ongoing operational annual cost of running the fund is 0.04% (0.94 minus 0.9).

This represents a relatively low drag on investment performance. But more broadly the figure can vary depending on the level of AUM and cost of service providers to a fund.

Over the last few years running funds has become more onerous from a legal, regulatory and administrative perspective. Increasing regulation has pushed up costs.

The upside is that today’s investors in funds are probably better protected from potential fraud and mismanagement than ever before. However, the extra administrative and regulatory burden has come at a financial cost, the bulk of which is footed by the investors in the form of ongoing operational charges.

SCALE ADVANTAGES

At this point it may be useful to explain the importance of scale. Funds with higher AUM have an advantage over smaller funds because operational costs are largely fixed.

In other words, as AUM increases, fees grow faster than operating costs. This translates into a lower performance drag which benefits overall investment performance. 

DEALING FEES AND SPREADS

Another cost which acts as a drag on investment performance is transaction-related costs associated with buying and selling stocks in the portfolio.

Buying and selling shares also incurs a dealing spread which is the difference between the buying and selling price. And then there is stamp duty tax, which in the UK is 0.5% for purchases over the value of £1,000.

Dealing costs are captured in the calculation of NAV. Fund managers have to publish the annual cost of dealing but it can often be difficult to find this information.

For example, the Fundsmith Equity Fund reported transaction fees of 0.01% last year and estimates the fee to be 0.02% over the coming 12 months.

For performance purposes funds report their net returns after all costs which allows a comparison across the fund universe.

It is important to remember that performance drag can come from the relative efficiency of running a fund as well as the annual investment fee.

PLATFORM CHARGES

The final thing to consider is the money you pay to your ISA or SIPP provider. Typically, you pay a fee to buy or sell a fund, and then an ongoing custody charge which is essentially the price charged by the investment platform to look after your investments.

For example, someone wanting to invest £10,000 in Fundsmith Equity Fund via the AJ Bell platform will pay £1.50 dealing charge and £25 annual custody charge to the company, and the fund manager gets £94.01 for the ongoing charge and £2 for transaction charges. That adds up to £122.51 or 1.22% of the £10,000 investment. You’ll find a cost calculator on AJ Bell’s website for each fund, such as this one for Fundsmith. Just select any fund and go the relevant product page, then click ‘Costs’ on the left hand menu.

For clarity, you pay the platform charges out of cash in your ISA or SIPP account, and the ongoing fund charges are deducted from your investment.

DISCLAIMER: AJ Bell owns Shares magazine. Editor Daniel Coatsworth owns shares in AJ Bell and units in Fundsmith Equity Fund referenced in this article.

‹ Previous2022-09-29Next ›