Ongoing Charges vs Transaction Fees

ChilliBob

Hey guys,
I'm looking on Fidelity's site to populate my SS JISA. (But this questions is relevant to any fund on any platform really). There's an Ongoing Charges % and a Transaction Fees %.  For some reason most tables only show you the ongoing costs, and you can only see the transaction fees by going into a fund profile. From what I can gather you may as well simply add both fees together. So, whilst an iShares fund might top the table with a 0.05 ongoing cost, the transaction fee of 0.13 means it's not as cheap as a Vanguard fund below it which has 0.06 ongoing and 0.03 transaction.
I've looked into it a bit and I can't see any other explanation (interestingly I see you can get some negative transaction fees and there's legitimate reasons for it so hey ho).

dunstonh

 For some reason most tables only show you the ongoing costs, and you can only see the transaction fees by going into a fund profile.

under EU directive MiFIDII, you are required to be told what the OCF, TC & IC (other) are in advance (on setting up) and in arrears at least once a year.

Some platforms do appear a bit lax on this. Either by only showing it during the purchase process and hiding it away otherwise or giving a generic figure rather than actual.

From what I can gather you may as well simply add both fees together. So, whilst an iShares fund might top the table with a 0.05 ongoing cost, the transaction fee of 0.13 means it's not as cheap as a Vanguard fund below it which has 0.06 ongoing and 0.03 transaction.

You should ignore TC & IC and focus on the OCF.     There are multiple calculation methods allowed for the TC that result in differing figures.   There is also the possibility of an element of growth or loss to be included as well (which can be by fluke rather than plan).    The methodology behind the figures is flawed.   So, yes they should be disclosed as it is compliant to do so but you should not use them in your fund selection filtering.

ChilliBob

Hmm, that's confused me then - as on the Fidelity website it does say you should look out for them, transaction costs, as they can rack up.  For example there was one with a very low OCF and a TC of 0.68 - which obviously that alone is very high for a passive fund (the area I'm concentrating on).

If they are a fee, you as an investor, have to pay, alongside OCF, why do they not factor into the selection criteria?

NottinghamKnight

It should be fairly easy for tracker funds as the returns are quoted net so after all costs have been paid, higher costs will translate as lower performance when compared with a similar tracker from a competitor, this won;t be the case so explictly for managed funds but then the argument is that they will outperform so should provide higher returns than passive instruments eventhough they will accrue higher costs and charges. 

dunstonh

Hmm, that's confused me then - as on the Fidelity website it does say you should look out for them, transaction costs, as they can rack up. 

Are they talking about transaction costs in the traditional sense or transaction charges in the EU directive sense?

 For example there was one with a very low OCF and a TC of 0.68 - which obviously that alone is very high for a passive fund (the area I'm concentrating on).

And does that tracker fund use a different method for calculating the TC than the others you are comparing to?  How much of that TC is down to a loss on a trade?  How much of the others you are looking at have a loss or profit in the TC?

If they are a fee, you as an investor, have to pay, alongside OCF, why do they not factor into the selection criteria?

You dont pay TC as an investor.  They are charges that the fund incurs to exist that are not levied on individuals but levied on the fund.       

ChilliBob

Take the following three, I appreciate this isn't a direct comparison since these thee funds track different indexes:
https://www.fidelity.co.uk/factsheet-data/factsheet/GB00BD3RZ582-vanguard-ftse-glb-all-cp-idx-�-acc/charges-and-key-documents

https://www.fidelity.co.uk/factsheet-data/factsheet/GB00BMJJJF91-hsbc-ftse-all-world-index-c-acc/charges-and-key-documents

https://www.fidelity.co.uk/factsheet-data/factsheet/GB00BJS8SJ34-fidelity-index-world-p-acc/key-statistics

Going on this, the Fidelity fund looks to have the lowest fees. If you click on the transaction cost if gives their definition. You can see from this description why I thought they should be considered. 

bowlhead99

ChilliBob said:

If they are a fee, you as an investor, have to pay, alongside OCF, why do they not factor into the selection criteria?

Here's a long and boring answer...

To run the fund normally holding investments over the course of a year, the fund needs to pay for a variety of services - fund management,  fund administrator, accountancy, financial audit, tax advice, legal and regulatory, registered office, depositary / custodian of the assets, annual meetings with investors, etc.   From an accounting point of view, all of those things are part of ongoing operating expenses and can be reasonably predictable based on the size of fund and nature of activities, and the largest component is management fees. In some case the manager will just charge a larger management fee and absorb all the other operating costs itself. All that stuff goes into OCF, and funds that have a lower OCF while producing the same gross return as their rivals (because they are just investing in the same things as their rivals, e.g. tracking an index) `will give a better net result. 

But transaction costs don't go through OCF, because they're not a charge for 'running the fund', they're just an incidental cost that the fund incurs when it buys and sells investments.  If Fund A spends its cash buying 5000 shares of Microsoft at £200 per share and 0.1% stockbroker fees, it will have spent £1001,000 on buying shares which are only 'worth' £1,000,000 at the end of the same day.  But the accountants don't say it has incurred an expense of £1000, they simply record that the acquisition cost of those Microsoft shares were £1,001,000, and they note that the fund's net asset value has declined from £1,001,000 to £1,000,000 over the course of the day (even though the fund's only asset, Microsoft shares, didn't go up or down on the stockmarket and the foreign currency rates haven't changed).

Later at the end of the year when the shares are worth £400 each and the manager sells them for £2,000,000, if it has 0.1% stockbroker fees, it will only receive £1,998,000 of sales proceeds. But again the accountants don't say the fund has incurred an expense of £2000. They simply say that the fund has sold an asset for £1,998k which it bought for £1,001k and has made a £997k gain on the disposal. Meanwhile the investor had started the year with a fund with £1,001,000 of cash in the bank and ended the year with a fund with £1,998,000 of cash in the bank, so agrees that the total return for the year was 99.6%.  What hits the profit and loss account in the fund's financial statements is the £997k of gain, and the implicit, incidental costs are not recorded anywhere. They impacted the return and the return could have been more if the buying or selling could have been done without any cost, or if there was no buying or selling, but they were not an ongoing 'running cost' of the fund, as they wouldn't have been incurred if the fund had just held Microsoft all year and had it double in value.   

The FCA would like investors to be able to compare all sorts of 'fees and charges' across funds so it would ask the fund to produce the 'transaction cost' numbers, even though the fund didn't record those numbers for accounting purposes because it was just concerned with recording total cost (£1001k) and total disposal proceeds (£1998k) so that it could tell the investors it made 99.6% for the year. The FCA doesn't care that the fund didn't have a standard way to track that cost exposure information, and thinks, "the average size of the fund for the year was about £1.5m (started about £1.0m and ended about £2.0m), wouldn't it be a nice thing if investors knew that the fund incurred £3k of transaction costs which is about 0.2% of average assets held, being blown on fees every year?  This would help investors differentiate between funds that use expensive stockbrokers who charge more for transactions and give free 'research' to the fund manager each year, and those that have a leaner service and make the fund manager pay for it out of their own pocket.    Also it would help investors avoid funds that burn cash by unnecessarily churning the portfolio, buying and selling just for fun. So in the interests of transparency we should make it a rule..."

So the fund has to produce the data and wonders where it will get it from - to break out this implicit cost of buying and selling asset into an explicit 'charge', when it wasn't recorded as an expense in the first place. 

It looks at the first transaction and sees that it approved a purchase of 5000 Microsoft shares for £201.50 each, budget was £1,007,500  and the order was placed. Then they look at the contract note from the broker where the final cost (due to some favourable market movement, fx difference, nice deal available in the market or whatever) was only £1,001,000.  Great, that's a negative transaction cost of -£6500... Put that on the list of transaction costs!  Then they look at the later sale and the market rate at the transaction time was £402 per share, so were expecting to get £2,005,000 for the disposal, but due to some issue with the large volume of trade they were doing, or some FX rate or fx commission or something, the final settlement pricing net of broker commission only left them with £1998k, which appears to be a £7k expense. So put that on the list of transaction costs.   

Then when you add the transaction costs for the year, positive and negative offsetting, it appears to be a net £0.5k expense.  Even though we know the broker charged them £3k across the two transactions. It's bringing market movements on asset prices into a discussion about costs, and changing the result.   And if the £0.5k (about 0.004%) is what they disclose for the 'actual' transaction costs for the year just ended, what will be the cost for the year about to start? Maybe they will just hold the shares all year and not do any buying or selling, and not have any TCs at all.

So being told 'TCs of x% were reported' has very limited usefulness.  The bottom line is, you know that the fund made 99.6% net return for investors (which you could compare to other funds with the same objective), and you know a theoretical 100% gains from the portfolio was never an option if there are any transactions because you can't actually transact without fees, so there is not much use being told that the fund had 0.003 to 0.004% of TCs, or even the theoretical 0.02% of TCs which the FCA might have expected to find.

The fund's own transaction costs are not really something that you or the fund explicitly 'pay' as a fee for operating the fund on an ongoing normal basis because they aren't true 'running costs' of the fund.   So the accounting standards don't require the transaction fees to be disclosed through the 'profit and loss account' separately as costs. They are just something that increases the total cost the fund pays to buy its assets or reduces the proceeds it gets when it sells the assets, so can reduce the total return that the fund makes, but they are an inevitable cost of doing business and if the fund doesn't need to do any buying or selling during the year (e.g. because they are just following an index and the index didn't have any new companies added or taken away), there will be no impact at all.

The impact of them will be felt in the bottom line 'total return' for the period - so with an index fund, if the total return is consistently less than the index being tracked minus OCF, a 'tracking error', this will point to them doing a poor job of tracking the index.  The difference may come from (a) poor management judgment of what shares to hold as a representative sample of the companies in the index, or (b) high transaction fees paid by the fund to its stockbroker whenever it buys or sells a stock, or (c) the fact that the fund is growing in size rapidly and has to buy a lot of stock to turn new cash subscriptions from investors into investments in stocks, and therefore is incurring more broker fees for that reason as it deploys its cash as well as paying more stamp duty on all those purchases.  

You can look at the fund and decide the tracking error is low so you are happy with it, or that the tracking error is high so you don't want it because it does a bad job of tracking the index, compared to rivals, for whatever reason you might imagine. But there is no real need to know the 'transaction charge' figure because it is only an estimate, and as dunstonh says, the multiple methods mean that one fund might disclose it differently to another. Some might even report negative transaction fees for some years, depending on the calculation method. The bottom line performance (the 99.6% in the example above) will tell you whether you are happy with how the fund performed against its rivals, and is a more meaningful comparison than some comparison of transaction fees where one fund calculates it one way and another another another.

If the transaction charges appear to be sky high it may be because they are investing in more complex assets with inherently high transaction fees (e.g. real estate, private equity) or perhaps just because the calculation method adopted is a bit garbage while still being allowable.  If you are looking at index funds (which should be able to achieve a known gross return before operating costs by following an index), you can compare what the fund's investors actually got with what the index got, to see if you're happy with it ; and with what the fund's rival trackers which follow the same index got, to see if you would prefer those - and an examination of TC is probably not going to add much of interest to your analysis.

ChilliBob said:

Going on this, the Fidelity fund looks to have the lowest fees. If you click on the transaction cost if gives their definition. You can see from this description why I thought they should be considered. 

In this case, the Fidelity fund is claiming the lowest TCs at 0.01%. The difference between that and HSBC at 0.04% is entirely immaterial. The difference between investing in an index that excludes exposure to several trillion dollars-worth of market capitalisation across 20+ emerging market countries (Fidelity FTSE World) and one that includes it (HSBC FTSE All-World) could be a whole percent - thirty times the size of the apparent difference - or more. 

And in their description when you hover over it, it notes the 'charge' includes not just broker commissions, but also the, 'change in price of the securities being bought and sold' between order being recorded and the final price achieved. That latter bit is simply some element of random dumb luck - as in my example of agreeing to pay £1007500 for Microsoft stock and getting away with only paying £1001000 due to a market movement in your favour at the last moment and saying that constitutes an overall 'negative transaction cost' of £6500 even though you literally paid the stockbroker's invoice of £1000 for doing the transaction for you (which was a real-world transaction cost of £1000).

dunstonh

In this case, the Fidelity fund is claiming the lowest TCs at 0.01%. The difference between that and HSBC at 0.04% is entirely immaterial.

It is worth noting that HSBC use the method that usually results in the higher TC and not the lower TC.       

TC really as a good example of an EU directive gone silly.   There have been calls to unwind a lot of MIFIDII now we are no longer in the EU.

ChilliBob

@bowlhead99 thanks for the really detailed reply, it was very useful. I can totally see how it could be irrelevant, if I understand if correctly.
Take the theoretical example of a new manger, perhaps they don't have the clout to get discounts on trades, but they work bloody hard and make some good decisions based on sound research, hence getting better returns, than a massive fund manager, who gets dirt cheap deals but is a bit lazy because everyone wants to be in their fund anyway! (i appreciate that analogy is a bit weak, and especially in the context of Index funds!). 

Thanks again  

Andrew895

hi, a bit late to this, however just recently I started "seriously" investing with Fidelity, though I'm a novice. I'm not sure I agree with some of the content above saying the transaction charge is not too important.

I started out wanting to know where the transaction charge comes into play, is it just when you buy or sell units (talking OEICS here, not ETFs or direct shares), or is it charged continuously like the ongoing fee.  Have a look at the Presale Illustrations Document by clicking a fund and seeing a section marked Important Documents. Click the Presale Illustrations link.  My understanding is that these docs are statutory requirements and should be accurate.

Scroll down to the last section, Ongoing Charges, and see that the transaction charge is simply added to the ongoing one.  You then add in the Fidelity fee and this gives a total, which is quoted near the start for years 1 3 and 5.  This is why I think you can't ignore the transaction charge - it seems it's actually charged in pounds and pence!  Why would Fidelity make their illustration look worse if they didn't need to show it because it was just "internal" to the operation of the fund?  (I'm looking at iShares 100 UK Equity - I see the the figures don't quite add up: .19 + .35 is .54 though .56 is shown on the first page.  But that might be a rounding peculiarity).

So @ChilliBob , I think your initial take on this was right.  I suppose I need to ask Fidelity directly about this.

dunstonh

I started out wanting to know where the transaction charge comes into play, is it just when you buy or sell units (talking OEICS here, not ETFs or direct shares), or is it charged continuously like the ongoing fee.

It is not charged at all.  It is a synthetic figure using one of two calculation methods (which can deliver different outcomes) to give you an indication of transaction costs that the fund may suffer (if ex ante) or has suffered (if ex post).

 Have a look at the Presale Illustrations Document by clicking a fund and seeing a section marked Important Documents. Click the Presale Illustrations link.  My understanding is that these docs are statutory requirements and should be accurate.

pre-sale means ex ante.  Whilst the OCF should be reasonably accurate, the transaction charges figure is flawed.  Which is why most ignore it.

  This is why I think you can't ignore the transaction charge - it seems it's actually charged in pounds and pence!

You are not explicitly charged the transaction charge (or the incidental/other charges column either).    The figures are put in pounds and pence because the regulator believes that people do not understand percentages. 

The TC & IC/Other columns are synthetic calculations showing what your share of the internal costs of the fund not covered in the OCF (or TER if direct assets) equate to.