Bid / Offer spread - a newbie mistake

arbster

A word of caution to other new investors, about a "hidden" cost of investing in funds. This may, of course, be obvious to everyone except me, but just in case...

I recently sought to increase the diversification of my portfolio by including some direct property investment funds. Given that these funds are relatively actively managed, and are not invested in a massively broad range of properties, I felt it prudent to spread my investment over a few funds. I went with:

L&G UK Property Feeder I Acc (0.63% AMC)
Henderson UK Property OEIC I Acc (0.87% AMC)
Threadneedle UK Property Inst Acc (0.83% AMC)

The annual management charges all seem to be high on such funds, so the L&G one looked like a decent option. However, what I overlooked in the documentation was the 4.51% bid/offer spread. So, upon investing in this fund, I was instantly 4.5% down, which more than offset the saving in the annual management charge. Of course, if the fund performs well, and I hold it for a long time, it might catch up, but my rough maths suggests that'll take upwards of 25 years. Disappointing.

redux

I thought the age of initial 5% on unit trusts and so on was supposed to be fading away.

arbster

redux wrote: »

I thought the age of initial 5% on unit trusts and so on was supposed to be fading away.

Not quickly enough for me, sadly. I'll not be putting any more into that fund.

Chickereeeee

redux wrote: »

I thought the age of initial 5% on unit trusts and so on was supposed to be fading away.

Ah but it is not an 'Initial Charge' (see eg HL site which shows 0% Initial Charge). It is a bid/offer spread....

I do not know if there is any difference in practice..

C

jimjames

arbster wrote: »

Not quickly enough for me, sadly. I'll not be putting any more into that fund.

Which broker did you buy through?

arbster

jimjames wrote: »

Which broker did you buy through?

AXA Self-Investor.

Zippeh

Thank you for your post, it's made me look again at my allocations and I was going to include the L&G property fund you had. I will look again now and see if it is worth the initial watering down.

Reaper

As a general rule Unit Trusts charge a bid/offer spread whereas OEICs (a newer version which most have converted over to) do not.

L&G seem to have a lot of the old style Unit Trusts still, see:
http://www.legalandgeneral.com/investments/fund-information/daily-fund-prices/fund-prices/actively-managed-funds.html

Incidentally Investment Trusts also have bid/offer spreads.

bowlhead99

I think you should read L&G's commentary at http://www.landginvestments.com/_resources/pdfs/An_overview_of_the_bid-offer_spread.pdf for a perfectly sensible explanation of why they use a bid-offer spread to cover the unavoidable costs associated with buying and selling property (including stamp duties, legal fees, agents costs etc).

When you subscribe more money into a property fund they have to go and buy properties with your money. When you want to exit they have to sell properties to get you your money. Not literally every single day when people subscribe or redeem - they have some liquid assets to ensure they are not constantly buying or selling physical properties on a daily basis - but look at the big picture of what a property fund is doing, and the costs are real.

The cost of buying and selling properties is significant - it's not like a fund buying a super-liquid share in HSBC or Shell through a broker-dealer - and the illiquidity of commercial properties is one reason why open ended funds are perhaps not the most suitable vehicle to run a property-focussed collective investment scheme, though that's a separate point.

You think you have just effectively paid an extortionate amount of money as a 'spread' and therefore it is going to take you a couple of decades to 'make back' this through reduced management fees compared to, say, Threadneedle. But that is a misunderstanding.

The reduced management fees (0.2% lower with L&G vs Threadnedle) are a permanent and annual saving for you. But for the other costs, do you think that somehow Threadneedle will NOT have to pay 4% stamp duty, 1% agent fees, 0.5%+ of legal fees when they buy their next property, and another 1% agent fees and more legal fees when they sell? Of course they will. And if Threadneedle do not attempt to bundle these costs into a difference between buy price and sell price, to cover their costs, and instead just operate a single price, then they are going to have a worse performance in terms of NAV growth. Alternatively, in practice they will swing the single trading price up towards e.g. £1.02 if there are a lot of buyers and down towards e.g. £0.98 when there are a lot of sellers.

Think of it this way. You and put £1000 into a fund at £1 per unit with 10,000 other people and the fund has £10m to spend on property. They buy property with a cost of £9.5m plus stampduty, agency/advisor fees, legal. Then you change your mind and want to get out. If the fund's only asset is a £9.5m property owned by 10,000 investors, how is it going to give you your £1000 back when you decide you'd like to leave and take your money elsewhere? It can't, unless it wants to lose money for all existing holders to benefit the leaver, which is commercial suicide. The price is going to have to swing between £1 and £0.95 as they do their property deals. Meanwhile the L&G fund has published prices of buy:£1, sell:£0.95, mid-price £0.975 which it maintains through the process. The Threadneedle fund simply delivers a 5% loss when its single published price changes from £1 to £0.95.

I agree if you are only investing for the very short term then clearly paying 5% spread when you can find a fund where you wouldn't, might be futile. But in the long term you benefit, because the new joiners and leavers who come in behind you pick up all the genuine costs incurred as a result of the fund's activities, and the fund gets a more 'pure' growth, which (ceteris paribus) will be higher than the growth of the other funds. You are not trying to 'make it back through the management fee saving'. You are making it back through all the subsequent joiners and leavers paying a spread. The management fee saving is a bonus on top.

One final point and excuse me if it sounds patronising because I don't know what you really know or understand about property funds.

The L&G main UK property fund is a PAIF (property authorised investment fund). Investors whose fund platforms can't handle the administration of PAIFs and the proper distribution of property income etc, and who are taxpayers, would probably choose to access it via the "feeder fund". Within the feeder fund, you lose 20% tax on the fund's income. If you were investing through an ISA or pension - as many investors on this site do - and therefore do not have to pay tax on your income, then it would be foolhardy to invest through a taxpaying blocker such as the "Feeder Fund".

As it mentions on the L&G's page for the feeder fund : "The UK Property Feeder Fund invests into the UK Property Fund". "Some investors may be eligible for greater tax efficiency by investing in our UK Property Fund instead, which is structured as a Property Authorised Investment Fund (PAIF)."

It is also worth noting that the Threadneedle UK Property Trust has also recently passed a member's vote to convert into the Threadneedle UK PAIF. So they will also have a main fund and then a 'feeder' arrangement called the 'Net' fund. So, once this eventually happens, make sure you're invested in the one most appropriate for your needs (it will be more tax efficient to be directly in the PAIF if you're an ISA or SIPP investor). However, by the time they got around to having the vote to convert to a PAIF, some tax rule changes on property transfers in Scotland had come in on 1 April 2015, which unexpectedly had no relief for funds converting to PAIFs, which means that the fund could find itself with a one-time tax charge on its Scottish properties when it turned into a PAIF. So, they have postponed conversion to a PAIF for now until the Scottish government clarify the policy intention. http://columbiathreadneedle.com/PAIF

HTH.

arbster

Wow... TWO newbie mistakes! Thanks bowlhead for such an informative and eye-opening response. Foolhardy I may be, but it's all a learning experience!

Plus

bowlhead99 wrote: »

I think you should read L&G's commentary at ... for a perfectly sensible explanation of why they use a bid-offer spread to cover the unavoidable costs associated with buying and selling property (including stamp duties, legal fees, agents costs etc).

In theory it would be possible to avoid this if the fund was structured as an investment trust: then you don't have to sell the property, just find another buyer for the shares. That would cause the share values to swing more widely according to supply and demand, but that would be a zero-sum game while having to sell the property itself incurs non-recoverable costs.

However all the Real-Estate Investment Trusts that I've managed to find are actually property development companies in disguise: they build shopping centres and whatnot, doing the designs, the construction, refurbishment and so on, as opposed to simply buying existing properties ready-built and leased and then collecting rents. That makes them very well correlated to equities, rather than a diversifying asset.

I don't know if PAIFs are any different, or is it just another structure for REITs?