Yesterday Citywire reported that two UK-based fund of funds managers, Evercore and 7IM, both of which have been prominent advocates of ETFs, are under fire for neglecting to include ETFs’ total expense ratios in their own managed funds’ expense measures.
Factsheets for the Evercore PanDynamic funds, for example, available on the manager’s website, show the total expense ratios for the retail share class as 1.1% per annum. That’s 0.9% to the fund manager and 0.2% to cover administrative charges, the PanDynamic range’s prospectus makes clear.
However, Evercore’s PanDynamic funds invest exclusively in ETFs, which of course charge their own fees as well. The PanDynamic Growth fund had its three largest positions at the end of August (representing a collective 40% of the fund) in the iShares £ Corporate Bond ETF, the db x-trackers MSCI Emerging Markets ETF and the iShares MSCI Far East ex Japan ETF, which charge 0.2%, 0.65% and 0.74%, respectively.
Should Evercore be including these underlying fund charges in the overall expense figure it shows to clients? Undoubtedly, in my opinion.
Unfortunately, it’s easy to think of several other cases where fees are added to fees without the end result being advertised to the investor, even where notionally low-cost ETFs are concerned. db x-trackers’ hedge fund index ETF, for example, which claims a total expense ratio of 0.9%, tracks a basket of hedge funds on Deutsche Bank’s managed account platform, all of which will levy their own fees before the index return is calculated. Being hedge funds, those fees are not cheap – but an investor in the ETF gets no measure of the cumulative effect of the charges, even though he pays them.
Where another hedge fund product is concerned, the MW TOPS Global Alpha ETF website spells out a little more clearly that its fund fee of 0.25% is going to be levied over and above a 1.5% management fee and 20% performance fee on the underlying index components. Those charges will land the end-investor with a total bill of well over 2% per annum if the fund produces any respectable positive return, though (something the MW TOPS Global Alpha fund has so far failed to do).
Perhaps the average investor in a fund of funds does have some idea that he’s going to be charged twice – at the umbrella fund level and at the underlying funds level – and, after all, there’s nothing forcing the investor to buy such a structure. Usually, and especially using ETFs, you can put together a diversified portfolio yourself. If your umbrella fund operator adds value through asset allocation, fair enough: you're paying for it.
But fees are fees, they’re certain, and they detract from your ultimate return. If there are two (or more) levels facing the end-investor, then it’s misleading not to show the aggregate amount.
Unfortunately, umbrella fund double charging is perhaps the least difficult area when it comes to calculating real investor costs.
What about the cost of providing a swap for a swap-based ETF? If a fund pays a Libor-plus rate of interest to its swap counterparty, then those extra basis points above Libor will be reflected in an additional performance lag versus the fund’s benchmark, something that is not shown in the fund’s expense ratio at all, but which can only be measured after the fact. And if there is no Libor-plus charge, to what extent is the fund being given lower quality collateral in return for its swap contract? The “cost” of owning a sub-standard collateral basket is completely invisible in a fund’s tracking performance and might only appear in a bankruptcy event, but it’s there. Similar considerations of risk versus return arise when stock lending takes place. Is the fund bearing all the risk but gaining only part of the return? If so, that’s a cost too – but one that’s impossible to measure without greatly improved disclosure.
And what about setting a benchmark that’s too easy to beat because of the index’s dividend tax assumptions? If you then only match it, that’s also a cost to the end-investor, albeit one that’s completely invisible at first glance.
There’s almost no end to this. Clever fund designers will always try to generate more revenue for themselves from less, while those of us observing from outside (and the regulators) struggle to keep up. But weren’t ETFs supposed to be about transparency?