Funds & ETFs 

Investment trust fees confusion

While unit trusts and open-ended investment companies have to follow European Union guidelines on what they include in their total expense ratios (TERs), investment trusts, which do not fall under Undertakings for Collective Investment in Transferable Securities (UCITS) regulation, have no prescribed way of presenting their costs. This means that different data sources can have completely different TERs for the same trust.

In addition to not including trading costs, investment trusts have the option of omitting any performance fees from their TER. Reasons given for exclusion of this and trading costs are to enable comparison of costs common to all funds. Not all companies charge a performance fee, and in some years those that do don't charge it. However data providers such as Morningstar do include any performance fee that was levied, on the grounds that this is a fairer reflection of the trust's true cost.

"An investment trust might have paid no performance fee in recent years and have a TER of, say, 1 per cent," says Nick Sketch, senior investment director at Rensburg Sheppards Investment Management. "Then you buy it, anticipating that it is about to do very well, the performance fees kick in and you actually pay a TER of 3 per cent while you invest in it."

Data company Lipper says that the most useful and relevant performance fee figure for investors and others is not the performance fee that was achieved in any given period, but the performance fee structure itself together with the fund's performance. That said, Lipper, which supplies the data on the Association of Investment Companies (AIC) website, publishes two TERs where an investment trust has incurred a performance fee in the previous year. One of the TERs includes the performance fee, and one does not.

So, for example, equity income trust City of London has a TER of 0.49 per cent without the performance fee, and 0.5 per cent with a performance fee.

The difference is more marked in trusts in other sectors. For example, F&C Commercial Property has a TER of 0.94 per cent without the performance fee, and 1.56 per cent with it, while listed hedge fund Absolute Return Trust has a TER of 1.83 per cent, or with the performance fee 2.28 per cent.

"We regard the published Lipper TERs as about as good as we can readily get in terms of including the right costs, and often much more useful than figures from the managers, but they still need to be read with care," says Mr Sketch.

AIC data on investment trusts is available at www.aicstats.co.uk

Differing dates and debt

Perhaps an even greater complication with investment trusts is the fact they can take on debt, which is referred to as gearing. Investment trust TERs can be based on the net assets which does not include the debt taken on, or the gross assets, which does include the debt.

The following table shows how a calculation on net assets versus gross assets can produce different TERs on two investment trusts:

Investment trustTER based on net assets (%)TER based on gross assets (%)
Axa Property Trust3.581.83
Isis Property Trust1.851.18

Source: Lipper as at 31 January 2011

Furthermore, unlike open-ended funds, which have to use an average NAV over a given period, investment trusts are listed companies and can choose whether to use NAV at their year end, the start of their year or an average. Like other companies they all have different year ends so the data taken could be at different times of year and points in the markets. In periods of market volatility this can produce some very different results and make it hard to compare two trusts investing in the same assets.

To avoid the problem of different year ends, data providers such as Morningstar base it on the average net assets over the period in question.

Although there are a number of variations with TERs, the general principle that passive funds are cheaper than open-ended ones still stands. On exchange-traded funds (ETFs), for example, turnover tends to be much lower than on open-ended funds as they only need to buy and sell shares when they rebalance, and swap-based ETFs do not need to trade shares at all.

Investment trusts are also usually cheaper than open-ended funds as there is less daily administration, and there is unlikely to be any trail fee included. Management fees are also often lower, although performance fees are more common among investment trusts, especially ones which invest in more unusual assets, so you should check carefully for these.

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