It’s like the sinister moment in a film, when the lead character is replaced by a dead ringer with a mole in a slightly different place. While we investors carry on with our daily lives, the familiar old Total Expense Ratio (TER) is being quietly removed from the scene, and the Ongoing Charge inserted in its stead.

Both figures do much the same job, by providing a comparable number for the cost of investing that we can use to pit funds against each other.

But the difference between the two doesn’t amount to much more than parting their hair on opposite sides.

It leaves me wondering what on Earth is the point of the change?

You’ve got to be KIIDing

A fund’s Ongoing Charge is found in the Key Investor Information Documents (KIIDS) that accompany common retail funds like ETFs, Unit Trusts, and OEICs ¹.

The Ongoing Charge is essentially the percentage of your fund holdings that will disappear in costs every year.

For example, if you have £1,000 in the Magical Unidirectional Gain ETF (MUG) and its Ongoing Charge is 0.5%, then you will pay out £5 a year in charges:

£1,000 x 0.005 = £5

This charge is deducted from the return of fund rather than directly from your pocket, but it does not include all the costs of owning a fund (never mind the other costs you pay out to brokers and so on).

The shopping list of expenses that the Ongoing Charge represents appears to be indistinguishable from the TER, barring a few technical differences. And my random sweep of a handful of index funds and ETFs from various providers suggests that Ongoing Charges and TERs are practically the same in most cases.

The major exceptions are the HSBC index funds that feature prominently in Monevator’s Slow and Steady portfolio.

TERs for these funds have all jumped in the transformation to Ongoing Charges. The most extreme case is the Pacific fund, which has an Ongoing Charge of 0.46% in comparison to a TER of 0.37%.

But why the change in the first place? As if to underline the negligible impact it’s made, most product provider’s websites are swapping between the terms TER and Ongoing Charge as freely as Genghis Khan swapped between wives.

The price is not right

Created in a fit of regulatory spring-cleaning, the Ongoing Charge is meant to tidy up the nagging suspicion that the Total Expense Ratio confuses the hell out of investors because:

• It is certainly not a total summation of all the expenses investors pay. Neither is the Ongoing Charge of course, but then it doesn’t sound like it is.

• There was no enforceable requirement for funds to display the TER. Now they must show the Ongoing Charge figure prominently in the KIID.

So what significant fund costs are missing from the Ongoing Charge?

• Performance fees – Though you wouldn’t expect to pay these if you stick to index trackers.

• Entry and exit charges – The extra charges you pay when you buy or sell your holdings. Some of the ETF KIIDs mention a percentage charge in this category, but this doesn’t actually apply to retail investors like you and me. We pay our broker’s dealing costs instead.

• Trading costs – The commissions your fund stumps up to brokers to buy and sell assets. Frequent trading increases costs, but you’ll still have to scour the fund’s annual report to find its Portfolio Turnover Rate (PTR) if you want to get a handle on this.

• Stamp duty – Another trading cost, that’s only paid on UK equities. This one generally shows up in the fund’s tracking error and annual report.

Frankly, the change is a cosmetic one and falls a long way short of providing investors with a simple to understand figure that represents the true cost of investing.

The Ongoing Charge is about as accurate a price tag as the face value of a low-cost airline ticket before they’ve bolted on your baggage fees, credit card fees, and breathing oxygen charges.

In terms of progress, it feels about as significant as the invention of the blue Smartie.

Take it steady,

The Accumulator

1. These funds are regulated by the UCITS directives that help create a Common Market in European investment products.[↩]

Some good reads from around the web.

I suspect everyone is getting a bit bored of banker bashing again. I am, and I was at it only a couple of weeks ago!

Boredom is not a solution, though. There needs to be change, or financial insiders will continue to capture an undue share of the profits of our capitalist system, while periodically wreaking havoc doing so.

In the lively discussion that followed my latest post, a couple of readers suggested I was unfair for expecting bankers to be less venal, selfish, and self-justifying than the rest of us.

But that’s not the case. I don’t.

My argument against what was once almost banker deification – stretching way back before the financial crisis – was that we don’t give sufficient attention to the fact that they are just like the rest of us!

The ordinariness of bankers implies two important things:

Firstly, there’s no reason why ordinary people should earn superstar salaries for either doing routine work, or for gambling.

Yes, the best should earn a lot when they truly add value, and banking will never be supermarket check-out money. But the market is effectively rigged and anti-competitive, and prospects in banking should be more like they were in the 1960s and 1970s, before deregulation opened the honeypot.

Some in the City compare the best-paid bankers with rock star footballers. The difference is the best footballers are demonstrably better at football than 99.99% of everyone else in the world – as opposed to uniquely having access to the football pitch.

Secondly, the ordinariness of bankers means big banks should have similar incentive structures to other employers, instead of the current heads they win a fortune, tails they win a fortune scenario.

Bonuses should probably be scrapped altogether for most areas of banking. Bank employees could instead invest a portion of what will still be healthy salaries into discounted share schemes, like other office workers. The current system has repeatedly delivered bad outcomes for society and the economy, which shareholders and taxpayers have carried the can for.

Still not convinced? Read the superb indictment of big banking from Buttonwood in The Economist this week.

It points out four things we’ve learned about elite bankers:

1. The laws of supply and demand do not apply.
2. Success is down to personal genius; failure is caused by someone else.
3. What is lucky for an individual trader may be unlucky for the bank as a whole.
4. Resigning can be a retirement plan.

It’s well worth reading in full.

[continue reading…]

I have written quite a bit about corporate bonds on Monevator – but only because they looked unusually good value during the credit crisis, not because I particularly like the asset class.

Institutional investors were throwing everything overboard in late 2008 and early 2009 to stay afloat. As a result, higher quality ‘investment grade’ corporate bonds started looking too cheap compared to gilts and US treasuries, with the bond market seemingly pricing in unprecedented defaults in the wake of the collapse of Lehman Brothers in the US.

Since those dark days, corporate bonds have indeed posted positive capital returns. They’ve also delivered a decent income to those who bought at the lows and locked in attractive yields.

But as I suspected would be the case, equities (shares) have done even better!

Here’s the return from four iShares ETFs since the start of 2009:

• The FTSE 100 (Ticker: ISF) ETF is up 22.8%

• The iShares £ Corporate Bond ETF (Ticker: SLXX) is up 9.0%

• The iShares ex-Financials Bond ETF (Ticker: ISXF) is up 12.9%

• The iShares Gilt ETF (Ticker: IGLT) is up 12.0%

These return figures flatter the FTSE 100 tracker, since they don’t include any income paid out by any of the ETFs over the years. But that won’t be enough to take the top spot away from the equity ETF.

Corporate coordination

So what do these relative returns tell us about investing in corporate bonds?

On the one hand, nothing much. It was just the way the cookie crumbled.

In another universe, where England won the European Cup, the sun actually shone in summer, and the Higgs Boson turned out to be a dead earwig stuck down the back of a CERN monitor, UK blue chip shares stayed mired around the 4,000-level for years, despite things calming down in the corporate bond market after the initial panic. In that scenario, the corporate bond ETF would have beaten the FTSE 100 tracker.

Indeed, the very strong returns from Gilts – theoretically the safest of all the asset classes here, which should imply lower rewards – underlines the dangers of drawing conclusions from three years of data, especially when the three years have been as weird as the ones we’ve just lived through.

On the other hand, my feeling is what we’ve seen from corporate bonds compared to equities is what’s usually to be expected. (Gilts are a different matter.)

Here’s why. Corporate bonds are linked to company health, just as equities are (although in very different ways, of course). This means that when equities sell-off in times of stress and panic, corporate bonds can do the same.

That’s different to the situation with government bonds such as gilts, which tend to be more negatively correlated with equities.

True, corporate bonds are much safer than equities, and also less volatile.

But at the same time, equities offer the expectation of much higher longer-term returns as compensation for those drawbacks. That has been hinted at over the past three years, and it’s visible in the historical returns.

Taking together, this explains why I generally favour getting exposure to companies from equities (at the price of far greater volatility than with corporate bonds) and to stick to using government bonds and/or cash for portfolio ballast.

Reasons to invest in corporate bonds

Still, some people like or need more income, and not only from equities. And with gilts and cash at record low yields, income seekers are leaving their comfort zones.

Investment grade corporate bonds currently yielding 2% to 3% or more over gilts certainly look a lot more attractive than the mere 1% spread over gilts they sported in the days before the credit crisis.

• The best reasons for adding corporate bonds to your portfolio are extra diversification (with the caveats I’ve made above), and also a time horizon that means you don’t want to increase your equity holdings.

• Bad reasons might include an irrational fear of the stock market, or if you are chasing a higher income regardless of fundamentals or valuations.

• In between those two extremes of motivation would be the desire to dampen down the wildest lurches in your portfolio, while making a little bit more income.

The bottom line is that prudently investing in corporate bonds will probably deliver what you seek – clearly good – but on the downside it will probably also cost you in the long-term, with a lower total return than if you’d just added more equities and held tight.

The Order Book for Retail Bonds

There’s another reason for UK investors to look afresh at corporate bonds since the dark days of 2009, and that’s the subsequent launch of The Order Book for Retail Bonds (or ORB for short).

The London Stock Exchange introduced the ORB in 2010 to improve the accessibility of corporate bonds to ordinary Joes like us.

We could buy individual corporate bonds before the ORB, in theory. In practice, many UK retail brokers were on the wrong settlement system to enable the bulk of corporate bonds to be bought and sold by ordinary investors in our normal online accounts.

There were also very large minimum order sizes for some bonds – a mere bagatelle for a Mayfair fund manager, perhaps, but amounts that could alternatively buy a holiday cottage in the continent for most of us.

Liquidity could be poor, too.

Fast forward to now, and while it’s still relatively early days, the ORB seems to be delivering on improving access to corporate bonds, as well as making it easier to trade gilts.

When the ORB launched there were just ten corporate bonds and 49 gilts available on the service.

As of May, the LSE boasted:

“Continuous, transparent, two-way tradable prices in over 150 individual UK gilts, supranational and corporate bonds, all tradable in typical denominations of £1,000 or less.”

Along the way we’ve seen a string of new retail-targeted corporate bonds from the likes of Lloyds, Tesco, Provident Financial, and Severn Trent.

In May this year the ORB even announced a Renminbi-denominated retail bond from HSBC – the first non-Sterling bond open for on-exchange trading on its platform.

Most of the new retail bonds have sported flat coupons in the 5-5.5% range, though a few have offered higher yields. There have been a handful of inflation-linked issues, too.

Incidentally, a good place to keep tabs on retail bond launches is the Fixed Income Investor website, which has covered many of these bonds in its Bond of the Week articles.

Warning: Retail/corporate bonds are not the same as the ‘savings bonds’ from High Street banks. The latter are really fixed rate, fixed term savings accounts. True corporate bonds are not covered by the FSA, and you could conceivably lose all your money if the company issuing them goes bust.

One way to play the retail bond boom

Despite keeping an eye on the development of the ORB, my preference for equities means I’ve so far I’ve only invested in Tesco Personal Finance’s 5% issue in May, which will mature in 2020.

I might not hold it until then. This bond – like many other issues of the past year or so – is already trading at a slight premium, which leads me to a potentially cunning plan…

But allow me to first take a detour.

Currently I think shares look cheap compared to debt. I’d ideally like the LSE to enable private investors like me to issue millions in junk bonds just like the barbarian-styled corporate raiders of the 1980s. 🙂

I’d buy today’s blue chip shares with the proceeds, and pay the debt out of dividend yields. History, here I’d come!

Sadly that’s just a pipedream. We’re in the middle of a deleveraging crisis, and there’s no chance of me becoming the new Michael Milken.

However, my positive experience with Tesco Personal Finance – and a quick eyeballing of the price of other retail bonds issued so far – makes me wonder if another forgotten 1980s practice could be revived via the ORB market.

Readers of a certain age – I’m referring to ‘stagging’.

Stagging was the practice of subscribing to new share IPOs – typically the Thatcher-era privatisations of former state-owned industries – with no intention of holding any shares you were allocated.

Instead, you hoped to capitalize on the excessive demand for new issues by immediately selling your shares for a quick profit.

Three things made this attractive:

• Firstly, new issues were often ‘priced to go’, so you could be pretty sure they’d trade at a profit when they hit the market.

• Secondly, demand outweighed supply, adding to the potential for prices to rise on initial trading.

• Finally, subscribing to a privatisation IPO was cheap and easy for the average person, compared to conventionally trading shares in the pre-Internet era.

Much of the above is also true of retail bonds today, albeit on a far smaller scale.

Market makers appear to be slightly under-pricing retail bonds compared to prices in the open market, even though the demand for income has never been greater. The process of subscribing through an online broker that’s supporting a new bond issue is easy, too, with no stamp duty to pay and my broker charging no dealing fees. ¹

Now, it’s important not to over-stretch the analogy with 1980s stagging.

My Tesco Personal Finance bonds are trading at a 4.75% premium, which isn’t bad after a couple of months, but it’s hardly the soaring returns that 1980s staggers enjoyed.

More importantly, we’re in an environment in which interest rates have been declining – yields on the ten-year gilt fell to fresh all-time lows in June. This alone could easily explain the rising prices of the retail bonds, rather than any pent-up demand.

My gut feel though is that there’s a quick trade to be had in these new issues, in the current climate (provided not many market makers read this article!)

Indeed, in my first draft of this article I explained how I would experimentally stag the new Primary Heath Properties (PHP) bond, which has solid property assets backing it, a relatively short maturity for a new bond, and pays a semi-annual coupon of 5.375%.

But the offer period has closed a week early, such has been the huge demand for this new bond!

I suspect this means we will indeed see PHP’s new bond trading higher when it goes on the open market, though sadly I’ve left it too late to profit.

Remember: This is not standard retail bond investing!

Let’s be clear – I am entertaining the idea of stagging new corporate bonds as a short-term opportunity, not suggesting that trading new issues will be a lynchpin in securing my long-term financial future.

Speculatively buying one or two corporate bonds is no way to diversify a portfolio, and I’d only put a tiny amount of my money into any new corporate bonds.

Finally, any investment would be made in my active trading portfolio, where it’s frequently in far more speculative securities than this!

As ever, please treat this article as educational, and not as financial advice. My feeling that retail bonds are being priced to deliver a premium is pure conjecture. Do your own research, and seek professional advice if you need it.

Want to know more? In part two I look at whether it’s practical or even desirable to build up your own corporate bond portfolio via the Order Book for Retail Bonds.

1. My broker for one is paid a distribution fee by the bond issuer, but this payment does not come directly from your investment nor affect your yield.[↩]