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Fact Check: Further detail on fund costs and performance research

The Investment Costs and Performance research provides factual and empirical evidence of real outcomes and the investor experience net of all costs and charges.

This research takes into account only UK authorised investment funds, and not investments distributed through other products or structures such as pension schemes.

Comprehensiveness of data

  • Some concerns have been expressed that the sample in question has been cherry-picked.
  • The report used all the available data for equity funds and years in a database provided by Fitz Partners, an independent fund research company. This database has a comprehensive list of funds with portfolio turnover rate and transaction costs information.
  • All the information we used in the research is based on publicly accessible audited reports.

Measuring costs and performance over time

  • To accurately match transaction costs and performance, we needed to analyse both over the same period (i.e. fund reporting years). If we had taken calendar year performance, this would have been inconsistent with full cost reporting.
  • Our sample includes the annual long reports of 1350 equity funds and each report covers a full fund year. This fund year, and correspondingly the period over which transaction costs are reported, varies for each fund. We separated the sample into three periods according to the annual reports’ date.
  • Since an annual report covers activity throughout the year ended at the report date, our sample reflects fund manager activity through the later part of 2011, the whole of 2012, 2013 and 2014 and the first half of 2015.

Survivorship bias

  • We used all equity funds in the Fitz Partners dataset, which means that we included funds that eventually closed but had published annual long reports. This ensured that our results are not skewed by "surviving" funds.
  • IA sector returns calculated by Morningstar are also free of survivorship bias and show similar performance to what we find.

Ongoing charges figure

  • There have been questions as to whether the ongoing charges figure (OCF) includes costs such as custody and one-off costs.
  • The OCF covers all operating costs, including management fee, custody, administration, auditor fees, regulator fee, and depositary fee. It is different from the TER only in that it excludes performance fees.
  • The paper explains in detail in Part One why one-off charges (entry, exit, performance fees) are not part of the analysis. Briefly, entry fees have been reduced since RDR and are frequently discounted, exit fees are usually limited to early redemptions, and performance fees are less prevalent in the retail funds industry.
  • We reiterate that the analysis used bundled OCF which covers total cost of ownership (i.e. it includes the advice and distribution fees) and not just investment. Therefore, we are measuring the fund manager against a higher cost benchmark that would be applied post-RDR with unbundled share classes.

Portfolio turnover methodology

  • Portfolio Turnover rate (PTR) is an indicator of trading activity and the IA has presented an analysis of the pros and cons of different metrics.
  • Fitz Partners used the Securities and Exchange Commission’s methodology as it is one of the most recognised approaches to PTR and also to ensure consistency and comparability. The calculation is based on figures disclosed in funds’ audited reports and accounts.
  • We believe that the inherent double-counting in the UCITS methodology results in counterintuitive measures for the proportion of a portfolio that is bought and sold in a given period (i.e. turnover). This is a widely shared view, e.g. see independent views from Morningstar and Lipper.

Transaction costs

  • Transaction costs are not estimated using PTR figures but calculated as the sum of transaction costs for both purchases and sales.
  • The transaction cost figures for purchases and sales are taken from funds' published (and audited) annual long reports.
  • The paper acknowledges that implicit costs, including the spread a manager encounters when interacting with the market, are not quantified as part of the expected shortfall calculation. However, all implicit costs are fully reflected in the returns of the equity sectors analysed and the results show that implicit (and all other) costs do not have a significant effect on performance.

Research costs

  • Research costs are included within the commission payments made out of the fund’s assets to brokers and are taken account of in calculating the expected deviation from the theoretical cost-free return.
  • The broader discussion about use of dealing commission is not the focus of the research, but major change is coming in this area. In future, MiFID II will require fund managers to either levy a direct charge on clients to fund a Research Payment Account, or to pay for research out of their own resources.

Robustness of performance findings

  • The results indicate that on average across 16 equity sectors for a period spanning from the later part of 2011 to May 2015, investors paid 1.6% to get a fund return of approximately 13%, which was about 0.7% higher than the return from the benchmark.
  • When using all available fund return information from Morningstar to cover each sector we find that on average equity funds returned 1.3% on top of the benchmark – even more than what the analysis based on the initial sample would indicate.
  • As mentioned above, IA sector returns calculated independently by Morningstar validate the out-performance we find over the years in question.
  • Longer-term sector return data from Morningstar show that from January 2000 to December 2015, the UK All Companies sector has returned net of all charges and costs 4.1% per annum whereas the FTSE All Shares total return index has returned 3.8% per annum. This period covers both the dot-com crash and the 2008 financial crisis.

The role of mid-cap performance

  • Concerns have been expressed that a ‘convenient’ period has been selected when mid-cap companies have performed well.
  • The period of the study was not selected. As explained above, we used all the available information and the paper acknowledges that this is a relatively short-run dataset.
  • The questions around mid-cap performance are relevant for UK equity funds and this is indeed discussed in Part Three of the paper. Although precise portfolio composition analysis was not in scope, there is reason to believe that active UK equity fund managers overweighed mid-cap companies and if that is really the case, fund performance shows that this was to the benefit of investors.
  • Nevertheless, our analysis extends beyond UK equity and in fact looks across 16 equity sectors so the mid-cap argument cannot dispel the results as a whole.

Fund managers vs the market

  • Some comments reflected the view that fund managers on average cannot outperform the market.
  • The paper discusses in detail the results in the context of the assumption that fund returns would be expected to be on average approximately equal to that of the market or benchmark. We note in Part Three that this assumption, does not take into account that fund managers are not the only market participants nor the fact that both active and passive funds are included in the data set.
  • In the UK, fund managers own approximately 30% of the equity market and account for 40% of trading. This is a very different situation from previous years where foreign ownership of UK equities was much less prevalent.
  • Moreover, it needs to be taken into account that we analyse performance in the context of charges and costs. This is a different approach to carrying a performance analysis whereby the merits of multiple factor models are discussed.
  • The results show that funds across 16 equity sectors have on average covered all costs and charges and returned more money for investors than a (frictionless) benchmark would have.

We are committed to transparency

  • The Investment Association and the industry are fully committed to acting in clients’ best interests, and will continue to work to ensure that investors receive clear, comparable and meaningful information on which they can make investment decisions.
  • To this purpose, we are working on a new, standardised and fully comprehensive Disclosure Code that will include implicit costs and bring even more transparency in this area.
  • And once this brings further transparency of implicit costs, future analysis will take these into account and will also be extended beyond equity sectors – as stated in the paper.