Fund dilution levy: part of cost base?

JasonPr

I have some questions about the fund dilution levy some funds charge explicitly. My question relates to the Vanguard FTSE UK Equity Index Inc (VVFUKE, GB00B59H6H54).

When I bought this fund in November 2011 on Sippdeal/Youinvest, the statement said:

10 * 100 = 1000
Dealing commission: 9.95
Total: 1009.95
Fund manager's initial charge: 0.50%

When I bought the same fund again in May 2012 (again on Sippdeal/Youinvest), it said;

10 * 120 = 1200
Fund Dilution Levy: 6.0
Dealing commission: 9.95
Total: 1215.95
Fund manager's initial charge: 0.00%

Since then, I move to Interactive Investor and when I buy this fund I get a statement that's like that from Sippdeal from November 2011 (i.e. quantity * price = amount charged; no mention of up-front charges).

Why is the dilution levy sometimes charged separately and sometimes not? I thought Vanguard changed something between November 2011 and May 2012 but now that I see the statement from Interactive Investor I wonder whether it simply depends on the fund platform and there was a change with Sippdeal.

What are my shares actually worth? In the initial example, the statement says 10 units for 100 each, but if there's a 0.50% initial charge surely my units are not worth 100 each. Are they only worth 99.50 each?

When I sell these shares, what is the cost base? The different treatment of the dilution levy makes it painful to work out. In the first example, my units worth 99.50 were bought for 100 and my units worth 120 were bought for 120.60, i.e. I have to add the dilution levy if it's charged separately and deduct it from the real fund value when it's included.

Is this correct? Can someone share more information about this?

And then what about funds that don't charge the levy upfront, such as HSBC FTSE. When I buy a unit for 100, it's really worth 100 and I pay the levy through increased fees every year. Is this how it works?

bowlhead99

JasonPr wrote: »

Why is the dilution levy sometimes charged separately and sometimes not? I thought Vanguard changed something between November 2011 and May 2012 but now that I see the statement from Interactive Investor I wonder whether it simply depends on the fund platform and there was a change with Sippdeal.

Probably the individual platforms decide how to display it. If Vanguard didn't change anything (i.e. they always had a dilution levy) then Sippdeal just decided to change the way of displaying things.

For example, initially they said they had paid £100 to Vanguard for each of 10 units. However, if you were paying that much and Vanguard was slicing off a piece as dilution levy, the units must have really been costing you the NAV £99.502 +(0.5% x £99.502=)£0.498 levy. To you, how it gets split doesn't matter for tax purposes. Because your acquisition cost of the 10 units is ((99.502 + 0.498) x 10)+£9.95 = £1009.95. That's how much you paid to get the units.

The overall price you paid for the units (the £1,009.95, or 100.995 each) is what goes into your tax calculation - whatever the 'pure' NAV of the fund is, is kinda irrelevant. If you sold the next day you would be selling at the next day's NAV (which would be 99.502 if it was unchanged, but in reality will probably have changed) and then paying £9.95 fee again so you would get back about £985. You would compare that to the £1009.95 and see you'd made a £25 loss for your tax comp.

Pulling out an old 2012 contract note from sippdeal I can see I added £6k of Lifestrategy 100 which had same fees shown on the contract note as your second example. I bought 57.7713 units at £103.63 for £5,986.84 and then paid £13.17 of dilution levy to take me up to £6000.01. Then £9.95 to sippdeal. For that trade I paid £6009.96 overall and that TOTAL cost is what I would say was relevant for the taxman. Despite the fact the units were individually priced at only £5986.84 before the levy and broker's commission. Actually, TBH the money is inside a sipp so I don't care about the taxman!

It sounds like your new platform is just doing your contract note simplistically, as Sippdeal used to do, and telling you what total money they paid to Vanguard. If you read the Vanguard factsheet you can see that the current levy is up to 0.4% (not 0.5% any more, they've reduced this) and so that amount that ii said you paid per share won't tie up to the NAV announcement for the day that you could get from trustnet or morningstar or iii or wherever you get your pricing.

What are my shares actually worth? In the initial example, the statement says 10 units for 100 each, but if there's a 0.50% initial charge surely my units are not worth 100 each. Are they only worth 99.50 each?

Yes, until the next day when they are 'worth' a different amount. The extra money went into the fund to help the fund pay stamp duties etc.

When I sell these shares, what is the cost base? The different treatment of the dilution levy makes it painful to work out. In the first example, my units worth 99.50 were bought for 100 and my units worth 120 were bought for 120.60, i.e. I have to add the dilution levy if it's charged separately and deduct it from the real fund value when it's included.

If you did that adding and deducting you would be confusing yourself and getting the wrong results. It can't be that you have to add on an explicit charge (to get the GROSS cost for your tax comp) if shown separately AND deduct the implicit charge (to get a NET cost for your tax comp) if not shown separately. The taxman is only concerned with the gross costs of buying in both cases. The bottom line number of what your contract note says, the cash that left your bank, is the gross amount. When you sell, it is the net number that comes back to your bank that counts for tax - net proceeds - after any fund exit fees, broker commissions etc. Again, the bottom number on your contract note.

And then what about funds that don't charge the levy upfront, such as HSBC FTSE. When I buy a unit for 100, it's really worth 100 and I pay the levy through increased fees every year. Is this how it works?

If the fund does not make any efforts to take specific fees off new investors who join the fund, then the costs of the extra trading and stamp duties etc attributable to net joiners and leavers and new cash needing to be deployed into the portfolio, will have to be paid out of the funds existing assets, thereby being shared by all investors. That results in a lower underlying performance over time.

The Vanguard funds expect the new investors to throw in a subsidy to help the fund out with (their estimation of) costs of joiners and leavers, which will obviously boost returns over the funds that do not.

If you are in an HSBC fund and have been there a while you will be 'suffering' these costs every year. If you are in a Vanguard fund, largely it is the people subscribing for new units that suffer the costs.

So contributing £1kpm, you start off paying £4pm dilution fee which is large relative to your total assets, but in ten years time you have contributed £100k+ with an asset value of £200k+ and are still paying £4pm on new contributions while being 'helped out' by a bigger amount of levies being charged to other new joiners - you're probably reaping the benefits of earning more levy from others than you are paying yourself on your own new additions.

JasonPr

Thanks for your detailed answer, bowlhead99!

JasonPr

In the meantime, I found the following document from Vanguard which describes the different approach taken to dilution:

Vanguard approach to protecting investors from dilution
https://www.vanguard.co.uk/documents/adv/literature/protecting-investors-from-dilution.pdf

One more question: you said Vangurd decreased the initial charge from 0.5% to 0.4% recently. This is correct but how can they do this when the SDRT is 0.5%?

bowlhead99

There used to be some slightly different and complex rules for OEICs and UTs under the UK stamp duty regime (Schedule 19), connected to investors redeeming their positions in the fund, in addition to the stamp duty the fund would pay when buying new shares. The rules were mentioned in that old Vanguard pdf you found, on page 5, and Vanguard considered 0.5% was a fair dilution levy to avoid all the investors having to share all the charges. But to help UK's competitiveness as a place to do business the Sch 19 stuff was abolished a little while back. So basically a fund is probably now just looking at paying SDRT as it buys new chunks of shares when it has new investor money to deploy.

If you think about it, if Vanguard has me and you and others subscribing new money one day, and gets £1 million in the door, it would ordinarily go and buy a bunch of shares on the market in the proportions of the index, and incur stamp duty and other transaction fees. However - if it also has £1m worth of redemptions from leavers at the same time, there is no point buying any new shares because it can just give our million to the leavers who want a million. So if subscriptions were matched by redemptions actually there wouldn't be any stamp duty or transaction fees.

To work out the impact of joiners and leavers on projected costs going forward, Vanguard undertook a review of the activities of their funds. They determined that new money from new joiners was outpacing money going back out to leavers by about 4 to 1. So they get a million in but won't need to buy £1m of shares, they only buy £800k of shares while £200k is used to pay redemptions. This means they only need to collect extra cash to cover their £4k stamp duty (0.5% of the 800k, 0.4% of the million) not £5k stamp duty. So the charge for you as a new investor can just be 0.4% and not 0.5%.

Obviously some of the shares they buy don't attract stamp duty anyway (e.g. companies who are FTSE listed but registered and operating in another country) but there are other costs associated with processing the purchases - broker & custodian fees etc, bid-offer spreads, together with the administration of doing the accounting and reporting for investors and moving the cash around etc etc. So they are using 0.4% as a rough rule of thumb. If net subscriptions slow down but they don't tweak the dilution levy, the fund will basically be getting more income than it needs for the incremental costs which will help the fund's performance. You may or may not see a change in the levy if the fund size contracts in a downturn and they want to be more competitive to attract new money.

As explained in that document you pulled (although there's a new version that superseded it), they are basically trying to reduce dilution effects for existing fund holders when new costs are attracted by the actions of a subset of the investors. They think it's the way the industry should work and obviously you can apply some form of dilution levy on large transactions by tweaking the subscription price or applying bid-offer spread to subs and reds, but an explicit quoted fee works quite neatly when they can blame it on a 50bps charge from HMRC in the case of funds with a UK strategy.

One thing it does is conveniently boost returns for the raw NAV performance, which is what goes in all the charts to compare against their peers! So they suffer less negative 'tracking error' than an HSBC or Fidelity equivalent for example, although as a new investor you have to pay the entry fee to get onto that nice performance chart. Downside for short term investors, upside for the long run.