By Annika Bradley and John Nunan 17 May 2016

The low down on managed fund fees and costs (Part 3): transaction costs and bringing it all together

Transaction costs are a reality of investing. In this article we explain how they work, where to find them along with other fees in a product disclosure statement and how to look at fees holistically.

Snapshot

  • The buy-sell spread refers to the amount that incoming and outgoing investors pay to cover the costs of their transaction
  • Base and performance fees shouldn’t be considered in isolation and the ‘package deal’ is what matters
  • The fees found in the PDS can require some piecing together, particularly since the move to short form PDS

In The low down on managed fund fees and costs (Part 1 and Part 2) we looked at how base fees and performance fees work across different types of managed funds. Now we’ll take a look at transaction costs and bring all these fees together, explaining how to look at them holistically and where to find them in a fund’s product disclosure statement (PDS).  

What is a transaction cost?

Transaction costs are any costs that arise from buying or selling investments.  For example, if you buy Australian shares you pay brokerage, or if you buy a house you might pay stamp duty. And when you buy or sell a managed fund, you pay the buy-sell spread.

What is a ‘buy-sell spread’?

The buy-sell spread refers to the small amount that incoming and outgoing investors pay to the fund (not the investment manager) to cover the costs of their transaction. This ensures existing investors in the fund are not footing the bill for costs incurred on applications and redemptions.

The buy-sell spread is why most managers publish three unit prices on their websites: net asset value (NAV), entry price (or application or bid price) and exit price (or redemption or offer price). Investors buying into a managed fund have to pay the ‘application price’ (which is higher than the net asset value) to compensate existing investors for the costs (mainly brokerage) the fund will incur in spending the new money. Similarly, investors leaving a fund receive a ‘redemption price’ (which is lower than the net asset value) to help compensate the remaining investors for the cost of the selling needed to raise cash to pay the departing investor.

Let’s take a hypothetical example. A managed fund called BHP Resources Fund invests only in BHP shares and the net asset value of each unit is $1.00. If you buy units in the fund, the cash you inject means the fund is no longer fully invested (i.e. perhaps now the fund has 5 per cent cash and 95 per cent invested in BHP).

The fund manager needs to buy more BHP shares to rebalance the fund and incurs brokerage of 0.25 per cent for the trade. The 0.25 per cent charged for this trade is not shared amongst all the other unitholders in BHP Resources Fund, instead you pay it, by incurring a slightly higher price than the current net asset value of a fund unit (that is, an application price of $1.0025).

The buy-sell spread ensures that despite the brokerage, the net asset value of each unit remains at $1.00. Similarly, when leaving the fund, you pay the brokerage by receiving a slightly lower price than the net asset value of a fund unit to cover the costs of the manager going into the market to sell BHP shares to raise the cash to meet your redemption (for example, the redemption price might be $0.9975).

It’s generally not a bad deal, particularly if you have a small amount to invest. If you invest $10,000 into a managed fund with a 0.20 per cent buy spread you get a portfolio of shares for transaction costs totalling $20. To buy that same portfolio directly would likely cost you hundreds of dollars in brokerage (because of the fixed minimum brokerage amounts).

Of course, it works in reverse if you have a million dollars to invest. In that case, you’ll probably find purchasing directly and paying brokerage works out cheaper. Online brokers tend to charge around 0.1 per cent for share trades beyond a certain value (often $25,000) while managed funds tend to charge a buy spread (and sell spread) of around 0.2 to 0.25 per cent.

Like the other fees we’ve discussed, buy-sell spreads typically vary with the asset class. It would be reasonable to expect to pay a slightly higher buy-sell spread on funds that invest in smaller companies as it often requires more skill and time (and therefore brokers can charge more) to efficiently enter and exit these stocks. For example, Celeste Australian Small Companies Fund charges a buy spread of 0.30 per cent and a sell spread of 0.30 per cent. Whilst the buy and sell spreads are usually the same, some funds do have unequal buy and sell spreads. For fixed interest funds, transaction costs are generally less and you should expect lower buy-sell spreads - Schroder Fixed Income Fund buy and sell spreads are both 0.12 per cent. The buy-sell spreads on a diversified fund tends to be somewhere in between.

Other costs to look out for

Managed share funds tend to just charge a base fee, performance fee and a buy-sell spread. However some might charge other ongoing fees that should just be treated as part of the base fee. For example, Platinum International Fund charges 0.10 per cent per annum of administration costs and 1.44 per cent per annum of investment management fees, totalling 1.54 per cent per annum of base fees.

Some funds – Dixon Advisory Group’s US Masters Residential Property Fund (ASX Code: URF) springs to mind – have fees that extend well beyond the usual array. URF not only pays Dixon associates base fees for investment management, responsible entity services and administration, it also pays for an array of transaction services. In the case of URF, the base fee is a drop in the ocean relative to the total costs, highlighting why you need to be across all the fees being paid.

Bringing it all together – total costs

This three part series has looked at base fees, performance fees and transaction costs – but from an investor’s perspective, the most important thing is the total cost incurred and how much this impacts your overall return relative to your objective. It’s also important to be able to find out what the costs are for a fund.

What is the total cost?

As we explained in The low down on managed fund fees and costs (Part 2): performance fees, the base and performance fees shouldn’t be considered in isolation and the ‘package deal’ is what matters. The ‘indirect cost ratio’ is the jargon used for the package deal and most (but not all) managers consider this fee to include base fees (including ongoing administration costs), performance fees and any fees payable on underlying funds (in the case of multi-asset, or diversified, funds).

Performance fees are inherently difficult to predict (as no-one knows the future) and typically fund managers disclose total fees based on historical periods to provide an indication of the fee incurred. For example, Australian Super’s Balanced Fund incurred 0.52 per cent of base fees and 0.05 per cent of performance fees for the year ended 30 June 2015. However, historical fees should only be used as a guide. If Australian Super’s underlying funds perform badly for the 2016 financial year the performance fee may be reduced to zero. There might also be differences in the base fees if the mix of underlying funds has changed.

The fees found in the PDS can require some piecing together, particularly since the move to short form PDS. The short form PDS was supposed to simplify things, but has resulted in investors often needing to check two documents – the PDS and an Incorporated or Additional information booklet – to get the full picture.

Let’s look at two examples: Celeste Australian Small Companies Fund (Image 1) and AMP Capital Global Infrastructure Securities Fund (Image 2). Celeste use what we would call ‘best practice’ for disclosing fees. This one section includes all the information necessary to understand the fund’s fees (with the exception of the buy-sell spread which is covered elsewhere).

Image 1 clearly sets out the management fee of 0.95 per cent and the fact there is a performance fee payable of 20 per cent of the return of the Fund that exceeds the return of the Benchmark. The Example 1 table then estimates this performance fee has amounted to 1.29 per cent based on the performance of the fund over more than a ten year period (disclosed right next to the table for easy reference).

This is a reasonable basis for estimating the performance fee as it is a long period of time and would ‘smooth out’ big up years and down years. That is not to say you should expect to pay a performance fee of 1.29 per cent next year, or any individual year, but it’s a reasonable estimate of what you might expect to pay on average over time.

Image 2 shows two tables extracted from the Fees and Costs section of the PDS for the AMP fund. While it is clear there is a management fee of 0.85 per cent, it is difficult to tell that a performance fee even exists. You need to read the footnotes to work out that the 0.85 per cent of management costs includes a performance fee estimated to be zero. To find out what the performance fee is (10 per cent of performance above the fund’s benchmark) you actually need to look at the separate ‘Incorporated information’ booklet. AMP certainly hasn’t made it easy to piece this one together.


So the ‘Fees and Costs’ section (usually Section 6) of a PDS is where you should find the base and performance fees payable, but what about transaction costs? The buy-sell spread can be a bit tricker to find as there’s no ‘standard’ way of disclosing it. For example, Celeste disclose their buy-sell spread in Section 2 of their PDS, but both AMP Capital Global Infrastructure Securities Fund (mFund) and Schroder Wholesale Australian Equity Fund put it in the Incorporated or Additional information booklets.

Fund managers often also disclose fees (or at least the highlights) in the monthly fund fact sheets (updates) or the fund summary page of their websites. But if you want to be sure you fully understand all possible fees there is no substitute for trawling through the PDS and Incorporated or Additional information booklets.

That’s the end of our three part series on the fees and costs of managed funds. We hope it’s helped you to better understand (and be able to assess) the fee and cost arrangements on any managed fund you are considering.

The fee structure is a very important component to any fund and the returns it’s likely to generate. An overly expensive fee structure should be enough to completely eliminate a manager from consideration for investment. If you have questions about the fee structure or transaction costs for a particular fund please let us know via the Q&A function.

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Disclosure: The authors own and have control over portfolios that own units in Celeste Australian Small Companies Fund and Platinum International Fund.