Fund management hidden charges – IMA report

A number of people have been asking me about my views on the report published last week by the IMA (Investment Management Association) about fund charges. Sorry for the delay in posting my comments but I have been awaiting to see if the authors reply to my clarifications. Unfortunately their reply was largely it was “not possible to answer without further work for which we do not currently have the time“.

I will therefore have to comment on what I see in their report and make the best of interpreting it. First I’d like to say that it is great step forward that the IMA is talking more openly about the hidden charges that affect investors. For so long, investors have been mislead into thinking that the TER included all fund costs, which course it does not.

In my book, I estimate that the hidden charges for an average fund are around 0.6%, (assuming a portfolio turnover rate of 60%) made up of:

Explicit costs:
  • 0.3% stamp duty
  • 0.1% commissions
Implicit costs:
  • 0.1% bid/offer spread
  • 0.1% price impact

It is encouraging that the IMA report does almost completely agree with my estimates on the explicits costs. Their estimates are:

  • 0.28% stamp duty/taxes
  • 0.12% commissions

In order to look at the implicit costs, instead of trying to work them out, their report decides to take a different tack and come about it in a completely different way. It looks at the “realised annual shortfall” of funds vs the market benchmark over the last 10 years.

To me, with my academic hat on, this just muddies the water and makes it very difficult to see again what is really going on. Having said that, if done correctly could provide some interesting statistics. The key problem with what they have done is that they have just looked at the performance of the 15 largest UK All Companies funds.

Why is this a problem? Well, firstly it excludes all those funds that are not doing very well and therefore are not attracting lots of money. Secondly, it ignores a substantial number of funds that got closed over the last decade. Note, the authors do try to take into account survivorship bias in some way, but to be honest that is not necessary as they actually have all the data to do it properly. Their response to my specific request for this data was: “we do not have the time to do this“.

To put it in perspective, below is (roughly) the performance of the funds (in green) they have looked at to deduce their conclusions. They’ve ignored the red and yellow funds and so statistically their findings are probably just not worth looking at as they are not representative of the fund population as a whole.

Another point about this report, is the revelation that the IMA appear now to be admitting publicly that their definition of Portfolio Turnover Rate that they’ve been supporting for years is the wrong one.  On page 10 of their report, they are seen to be using the correct SEC definition.

Can we have Portfolio Turnover Rate, defined this way, back in all fund reports please? If it is an useful enough number for your statistics department to want to look at in your own reports, don’t you think it might be interesting for punters buying the funds to know to also?

My final comment pertains to Table 8, which shows the shortfall of funds over time. Somewhat alarmingly the shortfall has increased quite markedly over the last 5 years. When asked if the IMA had an opinion on why this might be, the answer was: “No“. I suspect if most investors realised this increasing underperformance, they might be asking slightly more forcibly than me for an explanation.