Costs and Charges – an explainer

The subject for this Year’s AIC Directors’ Conference was regulatory change. And rightly so. As Peter Spiller (Co-Manager of Capital Gearing Trust) pointed out on a recent edition of the Money Makers podcast ‘governments and regulators have conspired against investment trusts in particular’. And so high on the list of topics for discussion at the conference was cost disclosures.

Why is this an issue now?

Investment trusts have been required to produce a Key Information Document (KID) since January 2018. The methodology for calculating costs for the purposes of this document differed markedly from that for producing the Ongoing Charges Figure (OCF) which had been the industry-standard way of communicating costs for years prior.

Amongst other things, the new methodology required investment trusts that invested in other collective vehicles include the underlying costs as part of their own. A trust which only invested in equities did not – a very twisted logic.

Until recently, this hasn’t been an issue – the KID document and methodology was being often ignored by investors. However, 2023’s Consumer Duty regulations require firms to evidence that consumers receive ‘fair value’ from their investments. The Financial Conduct Authority (FCA) defines ‘value’ as the relationship between the overall price the client pays for products or services and the benefits they are likely to receive.

Now, when wealth managers package together investments through model portfolios, the FCA requires them to complete an annual value assessment for each product and service. Unfortunately, though, the same twisted logic applies meaning that any wealth manager using investment trusts has to include and declare that trust’s own charges in their own – but if they just buy equities these are ‘free’.

The upshot of all of this is that since Consumer Duty came into force in 2023, wealth managers are less likely to use investment trusts because, optically, they look more expensive than they really are. So in an effort to protect their own fees, they are looking to cheaper passive investments.

What about the Direct to Consumer market?

The platforms Retail investors use to buy, sell and hold shares are also caught – and since 2018 have been presenting misleading tables suggesting that investors may lose money when an investment grows, because of the effect of mythical and/or double charges.

The problem is compounded by the fact some platforms unhelpfully use different numbers in different places. Hargreaves Lansdown, for example, show at least 3 different numbers for the same thing without any explanation for why they are different.

Interestingly, when you ask Retail investors to list the factors they consider when choosing an investment, charges are not the most important consideration. In fact, charges come 4th behind performance, availability of the investment on a given platform, and the sector or asset class into which the investment is being made.

What’s being done?

As we stand, a bill is currently progressing through Parliament which aims to remove investment trusts from the PRIIPs/Consumer Composite Investment regimes which would have the effect of removing these cost disclosure requirements. The AIC is supportive, but is suggesting an alternative methodology which would see three separate disclosures for one-off, ongoing and incidental costs.

At the same time, the FCA has permitted investment trust ‘manufacturers’ to add additional wording to their KIDs to explain how charges work.

Warhorse View: Getting this stuff right is important. Yes, costs may not be the single most important factor in why someone buys an investment; but at the same time they are a big part in why they don’t, especially when they aren’t explained clearly and succinctly. This matters in a world where ‘cheap’ is often conflated with ‘good’, and competition for investors’ cash is greater than ever. Investment trusts arguably already suffer by positioning themselves as more complex versions of open-ended vehicles, so Boards and their managers need to work extra hard to keep it simple, and support initiatives which aim to bring an end to this madness.