Alison Bostock from professional trustee company PTL looks at the issue of transparency around transaction costs.
The paper was roundly denounced as flawed by the Transparency Task Force, among others.
In October, the Financial Conduct Authority produced its long-awaited proposals on a standard way of disclosing transaction costs for workplace pension schemes, using the 'slippage cost' method. Consultation closes on Wednesday.
We have the trade body for asset managers saying transaction costs are a non-issue, we have activists saying that such hidden costs detract significantly from investor returns and the FCA attempting to find a way of disclosing them that all sides will sign up to
In December, the FCA commented that it had expected more progress on analysing transaction costs by providers using independent governance committees.
So we have the trade body for asset managers saying transaction costs are a non-issue, we have activists saying that such hidden costs detract significantly from investor returns and the FCA attempting to find a way of disclosing them that all sides will sign up to.
There is a long list of the costs of buying and selling assets, depending on the way the particular market operates. The list includes commissions for brokers and market makers, bid/offer spreads, taxes such as stamp duty, ticket costs from the custodian and the impact of the trade itself on the market price of the asset.
Difficult to measure
Sometimes commission is bundled into the quoted price, rather than charged as an explicit cost. The market impact of the trade can be hard to measure and varies according to the time of day the trade was made.
Not all these costs are necessarily borne by the fund, as in some cases the asset manager may pay them separately, effectively out of the annual management charge paid by investors. The charges that are borne by the fund act as a reduction to the investment return achieved by the fund.
As a further complication, you need to look separately at transaction costs incurred because the manager wants to change the underlying assets or 'value trading', and costs incurred because new money is coming into the fund and assets need to be bought or money is leaving the fund and assets need to be sold – known as 'flow trading'.
Without this distinction, closed and static funds will always look better at managing their costs than the busiest funds with high cash flows in and out.
The asset managers argue that, because transaction costs act as a drag on their published performance, they have every incentive to minimise them. Minimising costs can be done by negotiating the best rates with brokers, ensuring the best price is achieved on every trade and avoiding unnecessary trading or 'churning'.
They say that provided trustees and IGCs focus on performance net of transaction costs, the impact is already fully captured and does not need separate analysis, because in any case costs of trading are unavoidable and a necessary part of managing the portfolio to achieve investment returns.
On the other side of the debate, purchasers of asset management services argue that they cannot monitor and, if necessary, challenge costs if they do not have visibility of them.
Without disclosure of transaction costs, we cannot know exactly how well the manager has done at the two distinct tasks of firstly identifying trades that will add value and then executing those trades at the optimal price and cost.
Slippage cost
The slippage cost method tries to capture the whole cost of the trade, including the market movement aspect. This means that for some types of asset there is still room for judgment and approximation, but the method is easy to understand in principle, which gives it considerable merit in this complex debate.
It does not give every detail but perhaps we should view it as a starting point, rather than the end of the story.
As for what DC trustees and IGCs will do with the information – assuming they can obtain it from their managers, who are not obliged to provide it – to meet their duty to assess whether transaction costs are value for money, and how they can compare it between different types of funds, watch this space in 2017…
Alison Bostock is a client director at professional trustee company PTL
