Charges under the microscope

When you ask investment houses how much they charge for managing funds, they respond with a percentage referring only to their management fees, without including additional charges investors have to face. Information about these additional – and sometimes hidden – costs is now becoming the focus of more attention among distributors, although it is still not the most important factor considered by fund selection teams.

For the past ten years research firm Fitzrovia has been providing the industry with figures regarding funds’ total expense ratio (TER). This is the proportion of a fund’s assets consumed by all annual charges related to the whole fund management process. On top of the manager’s annual charge, the TER includes additional costs for other services paid for by the fund, such as custodian, registrar and auditors’ fees.

The TER usually represents between 1 to 2 per cent, and used to be lower, the larger the size of the fund. However, latest figures compiled by Fitzrovia for PWM show a different picture.

Table 1 shows the 10 largest Luxembourg-domiciled European equity funds sold across borders. The Fidelity Funds -European Growth (A) fund, the largest of them all with $14.93bn (€12.33bn) under management at the end of 2003, also has the highest TER of 1.96 per cent.

Table 2 shows the 10 largest European bond funds domiciled in Luxembourg. The biggest, Pioneer Funds- Euro Bond (E),with assets under management of $11.89bn, has the second highest TER of 1.10 per cent.

“It is interesting that the top funds have the highest TER, because in general one would expect that with economies of scale the total costs will be lower and for research we have done in the past, we know that the TER comes down quite significantly the larger the size of the fund,” says Ed Moisson, associate director at Fitzrovia.

The new trend suggests that the big funds – the Fidelity fund was the biggest selling European investment product in the first quarter of 2004, according to figures from Feri Fund Market Information – are notching up higher sales through providing bigger kick-backs to the distributors.

So how important are these figures when it comes to funds securing a place on distributors’ buy-lists? Not surprisingly, the fund manufacturers have played down the TER’s importance, as it is not in their interests to be seen improving sales figures through higher rewards to the middle-men.

A spokesman for the Italian Pioneer group says: “Total expense ratios are just one element of fund selection and should not be viewed in isolation from vital criteria such as fund performance, investment track record and a fund’s process and risk/return profile. Pioneer Fund’s Euro Bond has fund ratings from both Morningstar and Standard & Poor’s and in common with all our funds, all relevant fees and charges are clearly outlined in the fund prospectus.”

Fidelity’s salesforce, operating with military precision across Europe, claims not to have received any feedback from clients regarding the TER of the European Growth fund, which it claims is “competitive”.

But what do distributors think? Alvaro Chocano, marketing director at Allfunds Bank, part of Spain’s Santander group, says management costs are ultimately linked to the investment strategy of each fund management house and, in particular, to the fund’s own structure. “We all know that commissions are higher in equity funds than in bond funds because the resources needed to run these funds are different.”

But crucially, he adds that those investing in a high quality product should also be prepared to pay “extra”. When it comes to distributors, Mr Chocano explains that the fees to be paid are related to the type of share class you are choosing.

“Every fund will have its institutional share class where the commissions are very low. Then you will have a private banking share and finally you will have a retail type where the prices are much higher. Distributors use this share classes depending on how they want to use the funds,” he says.

Mr Chocano says retail funds distributors are much more sensitive to commissions rebates. “They want to know what proportion of the commission they are going to keep when it comes to selling the funds. Even if the charges are very high, if the fund and the commission rebate are good, the distribution will be more motivated to sell it,” he adds.

‘TER is unlikely to be the main criteria for distributors when selecting funds, but there seems to be more awareness of TER as a concept’ - Ed Moisson, Fitzrovia

A similar view emerges from Banif, Santander’s private banking arm and Spain’s most profitable wealth manager in the first quarter of 2004. “Every distributor is different. There are distributors that choose specific funds because their clients want retail funds or, maybe, they want to build a fund of funds,” says a spokesman at Banif. “Cost is just one element to take into account and it’s up to the distributors to choose the products that can meet their requirements. Distributors look for quality of management, and the price of the fund is just linked to the specific structure of each fund manager.”

Like other private banks, Banif allows clients to invest in third party funds including some of the largest European funds included in our research. As part of the Santander group, it would be most cost-effective for them to just offer in-house funds, but that is not what investors want, says the spokesman.

Private banks choose funds to complement their own product range and as a response to client demands. Cost is important, but the quality of the product is what keeps clients satisfied.

“Many distributors try to sell the idea of being independent, even when they are part of a large financial group and they want to offer third party funds” says Mr Chocano. “They don’t just focus on in-house management or the cost of using funds managed by others. They simply use the products that adapt best to their needs.”

At Fitzrovia, Mr Moisson agrees: “TER is unlikely to be the main criteria for distributors when selecting funds, but there seems to be more awareness of TER as a concept. Fund associations across Europe are asking managers to provide TER information, and more recently, the European Commission has come up with the recommendation that the new Ucits simplified prospectus should also include total expenses ratios,” he said.

For those investors interested in knowing more about all the charges they have to face when investing in funds, this is no doubt an important step that will contribute to more transparency in fees structures. But distributors, which may favour a higher TER with more fat to reward them for higher sales, will also be interested.

“The general trend that we have been seeing – and this is certainly the case for Luxembourg funds – is that management fees are rising and this has increased TERs as well,” Mr Moisson says.

‘If the commission rebate is good, the distribution will be more motivated to sell the fund’ - Alvaro Chocano, Allfunds

Until recently, the TER had been kept under control partly due to competition among administrators and back office providers, but increased management fees and the decline in assets that funds suffered recently have resulted in higher TER percentages.

Table 3 lists the 25 top fund promoters in term of assets under management in Luxembourg-domiciled funds and their average TERs for equity and bond funds. On the equity size, Italian group Fideuram, with assets of $38.4bn under management in Luxembourg funds, has the highest average TER representing 2.56 per cent. However the average TER of the group’s bond funds – 0.95 per cent – is one of the lowest on the list. Credit Suisse, Fidelity, BNP Paribas, Franklin Templeton, Nordea and Alliance Capital, have average TERs of over 2 per cent in their equity funds, whereas Fortis has the lowest average TER representing just 1.41 per cent.

The fund promoter with the highest TER in its bond funds is Alliance Capital with 1.7 per cent, which more than doubles the lowest average of 0.76 per cent at Swissca. Despite the fact that all the fund promoters listed in our research have assets under management of over $15bn in cross-border retail funds, TERs remain high, with wide variations among the different groups. Both distributors and manufacturers claim brand name and track record are the main criteria when it comes to choosing funds. But the fact that some of the biggest funds have some of the highest TERs suggests some connection between fund sales and charges, which can be rebated to distributors.