I was discussing product fees with a client recently and I commented:
“there are at least a dozen strategies that funds adopt to
enhance their fee competitiveness or improve their profitability.”
After making such a bold statement, I thought I had better put together a list. Half an hour later I had listed over 20 strategies that I have seen over the years. The use of these strategies across funds can have a material impact on relative fee disclosure and organisation profitability, despite the “true” underlying cost possibly being largely the same. I have casually added to the list which is now at 33 strategies.
The opportunist
Now, if you are an opportunist, then you are probably thinking:
Which of these 33 strategies can I employ to improve
our profitability or enhance our competitive positioning?
Hopefully, you are also thinking about how you are being disadvantaged relative to your competition and more importantly how the consumer, including you, may be being mislead.
Life was so simple
Not so long ago funds would appoint a small number of equity, fixed interest and property managers. Investments would be primarily via simple instruments (e.g. shares, fixed coupon bonds), and a custodian would help with the record keeping. The
Enhanced Fee Disclosure regulations were designed with this relatively simple world in mind. Today, funds are investing with a large number of managers, managing investments directly, engaging investment banks, using a diverse range of investment instruments and structures, with a custodian providing a broad array of services.
The regulations are now out of step with the “normal” investment arrangements of most funds.
Master custody case study
A master custody relationship provides a good demonstration of the issues and complexities that arise when trying to understand “true” cost versus disclosed fees. The custodian is earning revenue via:
- explicit fees for services (e.g. safekeeping, settlement, reporting)
- interest rate spreads on cash management
- spreads on foreign exchange transactions
- “revenue sharing” on securities lending
Of these, only part of the first item is included in the definition of the Indirect Cost Ratio (ICR, or MER for those that never got comfortable with ICR). Consequently, by definition, the disclosed fee only represents part of the “true” cost. In theory, you could have no (i.e. zero) disclosed fee, with these costs being fully subsidised by non ICR items. In practice, this anomaly can result in materially different disclosed fees despite common “true” total costs.
Tip of the “true” cost iceberg
Master custody arrangements are just the tip of the “true” cost iceberg making “true” fee comparisons near impossible. The issue of “true” cost touches all elements of a superannuation and investment product including product design, asset allocation, investment strategies, investment management, transition management, investment banking and broker relationships, and custodian arrangements.
This month I have decided to throw out a challenge...I will make a $100 donation (yes, we are not out of the financial crisis) to the charity of your choice for the first individual or organisation to email to me a list of 20 strategies.
Click here for an initial list to help you get started...
Enhanced “Enhanced Fee Disclosure”
Despite Enhanced Fee Disclosure including 35 pages of prescriptive regulations, the complexity of the industry, its products and services mean that you can knowingly or inadvertently disclose vastly different fees for products which have very similar “true” costs. Whilst further prescription may lead to better fee comparisons and more sound measurement practices, a fundamentally different approach is likely to be required....but that’s another newsletter!