I have slightly mixed feelings about the successful campaign to change the rules on how costs are reported for investment trusts. The sector has been treated harshly by the old rules, but there’s a risk of creating the impression that the way costs are calculated for trusts is entirely wrong. That’s mostly not true. The real flaw lies in how investors have been encouraged to compare different funds in a very simplistic way.
Costs are important in investment – unlike returns, they are under your control – but you need to compare like with like. If you are buying a tracker – ie, an exchange-traded fund (ETF) or an index fund – you can readily compare the ongoing cost figure (OCF) between any two funds. You should also consider if one tracks its index more closely and whether the bid/offer spread is tighter, but the OCF gives you a lot of information.
With an actively managed open-end fund, the process is similar. Here, you are weighing up the OCF against the chances that the manager will earn superior returns, so it’s not only about what fund is cheapest, but it’s normally fair to compare the costs of two active funds or an active fund against a cheap ETF as one part of your criteria.
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Investment trusts: discounts and diversity
Investment trusts are trickier because you often buy or sell at a discount to net asset value (NAV). This adds another factor to your assessment. A higher-fee trust on an unusually wide discount might offer the best value at the point of purchase.
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Beyond that, different types of trusts have very different norms. With a trust that invests in listed stocks and charges a conventional management fee, its OCF should be broadly similar to that of an active open-end fund. It may be fair to compare them, although you will also need to take into account gearing, dividend policy and other factors, as well as a discount to NAV.
Other trusts, such as those investing in private equity or physical assets, are different. They will normally have higher ongoing costs anyway – it’s the nature of their business. They may also charge performance fees. Transaction fees for buying and selling assets will be larger and vary greatly from year to year. So one of these funds may have a very high cost figure if it delivered strong returns or has done some large deals last year. You cannot compare these to a standard listed equity fund or trust, and even when comparing to similar trusts, you need to look at the breakdown of the fees.
Then there’s the “double-counting” problem. An adviser or fund of funds must aggregate the fees charged by its underlying investments into its own reported costs. If it held a trust with high fees, it had to incorporate the headline numbers at full whack – yet it may even have invested at a large discount to NAV. This has probably dented demand for some trusts and changes to the rules may bring them back to favour.
The curse of the KID
All this said, reported costs are as important for trusts as any fund. I don’t fully buy the idea that they are already priced into the trust’s shares via any discount to NAV. Investors need to see clearly how costs are arising on the underlying assets. High-cost ratios could point to an inefficient structure or too many fees going to the manager. However, the idea that one single number lets us compare all types of funds is nonsense.
This is yet another bad idea made worse by the misnamed key information documents (KIDs) imposed on funds in 2017. Apart from putting a heavy focus on OCFs, these asinine, information-free bits of paper are the reason retail investors in the UK and EU can no longer buy US-listed ETFs, which provide more choice and lower fees (US ETFs don’t publish KIDs, so UK brokers can’t let you trade them). When the government brings in new, trust-friendly rules on costs next year, it should also consign that rule to the bin.
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