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Who are you KID-ing? Understanding the ongoing charge figure of an investment trust

Who are you KID-ing? Understanding the ongoing charge figure of an investment trust post image

Updated: As if to underline the confusion caused by discussing different charge estimation regimes, the initial version of this article has been re-edited. Even we and the experts at the AIC got our wires crossed! What’s most important is that you have an accurate reflection of the current situation, so I’ve decided to publish the entire tweaked article again. Apologies for the fuss – The Investor.

Many of us retirement-focused investors have been won over by the charms of income-orientated investment trusts.

And when buying such trusts, in recent months we’ve become accustomed to formally acknowledging – via a tick box at our online broker – that we’ve read each trust’s Key Information Document (KID) at the time of purchase.

Some investors, I’m sure, do assiduously read KIDs.

But many more, I suspect, do not – or have briefly skimmed them once.

Personally, I don’t find them to be particularly useful documents, but maybe that’s just me. Read a KID, though, and it’s not difficult for the eagle-eyed to note that trusts’ costs, as disclosed within the KID, differ from the ongoing charges (or OCF) figure quoted in trusts’ prospectuses and monthly returns, and on popular information services such as Morningstar.

For example, the City of London income-centric investment trust has an OCF of 0.41%, recently reduced from 0.42%.

City of London’s KID, though, lists ‘other charges’ of 0.85%, in addition to ‘portfolio transaction costs’ of 0.03%.

So which costs figure is correct? Why are there two very different figures given for seemingly the same lump of costs? Is some sort of investor rip-off taking place?

Monevator reader Tony B e-mailed us about just such a situation. What was going on, he asked.

Apples and oranges

At which point, let me refer back to a little ancient history.

Many years ago, back in the days of the Total Expense Ratio – the forerunner of today’s OCF – I’d encountered something similar in the context of index trackers.

The culprit? A Financial Services Authority-mandated formula for calculating costs, which had specified the inclusion of some costs that the tracker industry had traditionally excluded from its calculations.

Nothing underhand was happening, and the differences between the two calculations showed up in each tracker’s tracking error.

It was possible that something very similar was going on here, I reasoned. But I couldn’t know for sure that this was the case.

For valuable readers like Tony B, we like to go the extra mile to get to the facts.

Call the experts

So I picked up the phone and called the Association of Investment Companies (AIC), which is the trade association representing investment trusts.

I knew it had been running a vociferous media campaign, arguing against the unthinking imposition of KIDs on the investment trust industry.

Where do KIDs come from? Imposed Europe-wide on the collective investment industry at the start of 2018, KIDs caused a number of difficulties, specifically in terms of the measurement of risk and performance. So much so, that open-ended investment funds (OEICS) have now been exempted from the requirement until 2022, by which time it is hoped that the problems with them can be fixed. But closed-end funds – investment trusts, in other words – haven’t been granted equal exemption.

Ever helpful, the AIC provided me with chapter and verse.

Here, thanks to Ian Sayers, the AIC’s chief executive, and Annabel Brodie‑Smith, the AIC’s communications director, is the low-down on what Monevator readers need to know about charges and KIDs.

The facts, and just the facts

  • Every investment company1 KID follows a standardised cost disclosure, showing a projection of the impact of costs over the next one, three, and five years. The ‘other ongoing charges’ section of the KID shows the costs of the investment company managing its investments and the costs of running the company, such as accounting charges, but it also includes the costs of borrowing and stock lending.
  • On the other hand, the standard AIC-defined methodology used by the industry calculates ongoing charges based on the expenses levied by an investment company over the last financial year. The ongoing charge includes the costs which investors can expect to reoccur each year, so it includes an investment company’s investment management charge and the costs incurred running the company such as directors’ fees and auditors’ fees.
  • Importantly, the AIC says the ‘other charges’ figure quoted on the KID already includes the OCF. The two charges are not additive. In the case of City of London, for example, the KID methodology suggests overall costs of 0.88%, made up of ‘other charges’ of 0.85% (which includes the OCF of 0.41%) and ‘portfolio transaction costs’ of 0.03%.
  • To compare investment companies and OEICs, investors should use the ongoing charge because this is the same methodology currently being used by open‑ended funds. When comparing investment companies, the traditional OCF will provide a consistent basis of comparison, but KID-derived figure may not, because the KID rules allow for different interpretations and can lead to different outcomes.
  • The KID cost figure is best thought of as a set of costs, projected into the future, based on certain assumptions regarding investment company performance. The traditional OCF is best thought of as a set of (mostly different) actual costs incurred in the most recent financial year.

What to make of it all?

The AIC and the investment company managers that it represents are in no doubt: KIDs are flawed, and must go.

“The AIC has argued strongly for KIDs to be suspended as their flawed methodology for calculating risk and potential returns could be dangerously misleading to investors,” its chief executive Ian Sayers told me. “We have repeatedly called on the FCA to protect consumers by warning them not to rely on KIDs when making investment decisions.”

“The implementation of KIDs for UCITS funds has recently been delayed by two years to January 2022. We believe the KIDs rules should be suspended because they are systematically flawed due to their reliance on past performance as a basis for future projections. We need time so the rules can be fixed once and for all: if KIDs are not good enough for open‑ended investors, then they are not good enough for purchasers of investment companies.”

My take? Not for the first time, we see – doubtless well-meaning – financial regulators muddy the waters.

Whatever fix eventually emerges the likely impact will be deleterious.

With an investment industry repeatedly and loudly calling for KIDs to be fixed — and to be dumped until they are fixed — the result is that the KID brand is in danger of being irreversibly tarnished.

That’s not good for investment trust investors. It’s not good for the investment trust industry, either.

Read all of The Greybeard’s previous posts on deaccumulation and retirement.

  1. The AIC talks about investment companies, and I have retained that usage here. For most purposes, and most investors, investment trusts and investment companies can be thought of as being the same thing. All investment trusts are investment companies; not all investment companies are investment trusts. And although this isn’t the only difference between the two, investment trusts are UK-domiciled, while investment companies need not be UK domiciled. []

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{ 14 comments… add one }
  • 1 e17jack January 29, 2019, 10:14 am

    This is something that has troubled me before – i used to hold some RIT Capital Partners as one of a few investment trusts, and blindly trusted the quoted OCF of 1.02%

    However a random forum post alerted me to the fact that this is deceptive. On checking the KID, the true cost is a whopping 4.17%. YES! Over 4%! This includes ‘Portfolio transaction costs’, ‘Other ongoing costs’, ‘Performance fees’ and ‘Carried interest’.

    To make matters worse – i just checked the OCF across several sites and HL quotes 1.02% (plus ‘Annual management charge of 1%) while Trustnet quoted 0.66% (no mention of further fees).

    The system is a mess and badly needs overhauling. It’s so depressing that they can’t just get it right – vested interests?

    (Needless to say – i sold the RCP)

  • 2 John B January 29, 2019, 10:34 am

    Interesting about City of London, as that’s an oft-quoted Investment Trust for its solid returns. It seems in the great Active/Passive war, ITs often escape salvos about high charges, as if they were mythical altruistic organizations, not fund mangers with a different wrapper (and income smoothing bent).

  • 3 Mr Five 2 Fire January 29, 2019, 10:50 am

    So which one is right? Surely a cost is a cost. For instance if I go buy a pint of milk no one tells me that its 0.42% of my total shopping but then you have to pay a service charge of 1.22% and a transaction fee of 0.13%. When I hear about things like this I think that the whole system has been rigged by people who are just trying to part you from your money. The worst thing is that they don’t tell you about it!

  • 4 ITinvestor January 29, 2019, 11:04 am

    I wrote about this last week as it happens. As The Greybeard says, it’s a real mess at the moment so it’s great to see it getting brought to people’s attention.

    One thing I didn’t appreciate is that the two costs were additive (but admittedly I didn’t phone the AIC). I thought that the ongoing charge for City Of London, which is primarily its management charge plus a few extras for admin costs, would included in the 0.85% other charges set out in its KID.

    Some KIDs, like RIT Capital Partners for example that was mentioned above, do make it clear that the costs do include management fees. From what I have seen, some companies are pretty good at breaking down the costs listed in their KIDs into several categories, while others just lump them together.

    In City Of London’s case, I suspect a lot of the 0.85% relates to interest costs, as its current gearing level is 12%. In rising markets (remember them), the gearing that investment trusts can take on should lead to additional performance that outweighs these borrowing costs.

  • 5 The Investor January 29, 2019, 3:08 pm

    @ITInvestor — I have heard back from Greybeard, who has heard back from the AIC, and it seems there was an error in communication here that made it through the system. As soon as I know exactly what’s right, we’ll change it.

  • 6 The Investor January 29, 2019, 10:12 pm

    @all — Post is up again now, as you can see, with the correct numbers. Miscommunication on both sides about what “additive” meant!

  • 7 dearieme January 30, 2019, 1:09 am
  • 8 weenie January 30, 2019, 12:30 pm

    “But many more, I suspect, do not – or have briefly skimmed them once.”

    Thanks for the reminder that I’ve only ‘skimmed’ the KIDs – they were an eye-opener but fortunately, nothing too shocking!

  • 9 HariSeldon January 30, 2019, 8:01 pm

    Might I suggest that if you are looking carefully at an Investment Trust, download the accounts.

    The accounts are not as frightening as they may appear at first. Look at the size of the company , the capitalisation. ( Generally best to look at the NAV , consider the effects of gearing increasing the size of the company assets)

    Take a look at the expenses, you will see the effect of the OCF and on top of that you can see the running costs of the company, directors salaries, taxes, audit fees etc. Take at look at the borrowing costs, any performance fee etc. There are invariably useful notes in the accounts relating to the costs.

    With the expenses divided by assets multiply by 100 and you have your own %charges figure. It may not be perfect but it will be pretty close and provide a useful means of comparing one trust to another.

    The internet makes it so easy to get the information, I recollect in the 90’s ordering up hard copy IT accounts and it was rather alarming to have a box of around 25 or so come at once!!!

    There is an enormous amount of information to be gained from reading the accounts…

    In a similar fashion ETFs publish accounts and the actual quoted charges, low as they may be, are dwarfed by the effect of withholding taxes and the costs of turnover in many cases. Interesting reading.

  • 10 Ben January 31, 2019, 10:46 am

    For trackers, could you not just measure tracking error?

    In theory that should encompass all costs. And as an investor, is not most useful to view your ‘costs’ as the tracking error?

  • 11 ben January 31, 2019, 7:00 pm

    “differences between the two calculations showed up in each tracker’s tracking error.”

    This is 100% untrue. Fixed costs don’t appear in a tracking error, they appear in the tracking difference. This may sound like pedantry but it isn’t. The tracking error shows the effect of non-perfect replication, which is totally different despite the name similarity. I wish we could all learn to use these correctly.

    With regards RIT etc, I too am flabbergasted by these vast fees. It could be a mistake, or perhaps multiple layers of fees (funds containing funds). No way should trading costs get anywhere near these levels though! Maybe it’s stealth management charge.

  • 12 MrOptimistic February 1, 2019, 7:12 am

    I am a fearful little soul and don’t wander away from mainstream stuff. I dont read the KIDs although sometimes have to tick a box claiming I have read them to enable a transaction. Greatest problems I have are with fund of funds type things, trying to figure if all the costs have been rolled up into the OCF or if I have to try and work it out myself. That, and trying to establish the effective duration of bond funds.

  • 13 Ben February 1, 2019, 8:49 am

    @ben 11 (nice name 🙂 )

    Yes your right, (I made the same error) although I was referring to an error in tracking, rather than ‘tracking error’, didn’t realise there was an actual name for what I wanted.

    Link here for anyone else
    https://www.etf.com/etf-education-center/21030-understanding-tracking-difference-and-tracking-error.html

  • 14 HariSeldon February 2, 2019, 5:33 pm

    @Ben

    I looked hard at various Canadian ETFs. The ishares product appears to have the highest charges of those I liked at, but when you compared the performance , over equivalent periods, then the ishares product performed far stronger than the alternatives.

    In addition some ETFs out perform the index , because the index includes a deduction for taxes , which are higher than the ETFs…

    It’s not always easy

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