Investment Costs in Europe: ‘Game of Thrones’

Foreword by JB Beckett, Author of ‘New Fund Order’. Director of the Association of Professional Fund Investors.

“Transparency should be the great equaliser of the mutual fund industry. With it fund investors make informed decisions, to compare funds (and products) and identify Value for Money. However there are many vested interests within this industry, and the transparency movement, that coalesce and contrive to frustrate that outcome. Whether it is intellectual pride, professional competition, material interest or less benign collusion; something has occurred to distract and dissuade fund investors from cost analysing mutual funds accurately, reliably or universally.

Consequently instead of cost transparency being an easy question; it is far from it. This creates added work for the fund investor when time would be better spent on less certain variables like people, process, portfolio and performance. The work of Sunil Chadda then is a trusted voice and I commend him to you, to fund investors, pension schemes and asset managers.”

Background - Game Theory

I write this article in a personal capacity as an extremely concerned investment costs specialist, one who has researched and worked actively with investors, asset management groups, various industry bodies and regulators over the last 5 years.

In my opinion, the chances of achieving “true” investment cost transparency, at this juncture, are remote and diminishing by the day. There are just too many open questions - investment cost transparency has become shrouded in varying cloaks of, ironically, transparency. They leave the waters as the muddiest that I have ever seen. You can’t drink safely from a muddy pool.

So, what exactly has gone wrong?

Introduction - The Great Game

I refer not to the Great Game of the 19th century involving empires, trade routes and roaming pundits that was played out in the mountain ranges of Central Asia and India, but to another Great Game, for that is what it has become, being played out before our very eyes in our industry, in the 21st century.

This new Great Game is all about transparency – transparency related to the true initial and true ongoing costs inherent in financial products which, for some reason, remain unknown to us at the time of purchase. This modern Great Game is being played out at both a macro and a micro level on European soil and globally.

Price Discovery, the essential pre-requisite for any orderly and properly functioning market in goods and services, has become “Prices” Discovery – are the “discovered” prices in any way complete and accurate and, if so, which one price is the most accurate for the fund investor, you and your pensions and lifetime savings?

At the macro level, the actors include the European Union (EU), EU sovereign states, EU and local regulators and asset management groups, industry bodies, other industry players and, last but not least, investors.

Meanwhile “B” – BREXIT simply adds another layer of complexity to the Game.

At the micro level, the actors are the various cost transparency initiatives, whether regulatory or industry body-led, which promise to capture ALL investment costs but, for one reason or another, struggle to achieve their intended goals.

In the Game these actors, whether macro or micro, are, at times, acting independently of each other and on other occasions are acting together, sometimes visibly and sometimes not.The end result is a dramatic increase in asymmetry and complexity for investors and the governance bodies that represent them. Many of these governance bodies will have regulatory obligations around understanding transaction cost and investment cost levels and/or Value for Money (VfM).

A declaration of VfM cannot be made until such a time when all costs and other incomplete factors have been fully and accurately bottomed out. With all of the regulatory and industry body investment cost transparency initiatives producing different monetary amounts for specific cost items and, therefore, different monetary amounts for the total cost of investment – it is not hard to imagine the prisoner’s dilemma facing governance bodies. Which templates do they trust, which do they publish and what exactly is the quantum of any missing costs and are they material?

Furthermore, what happens should a governance body track only a small subset of the available cost metrics - tracking them all properly is nigh on impossible - and be blind-sided when an angry pension fund member takes legal action based on another cost metric or set of cost metrics?

[JB on Prisoner’s Dilemma. I agree with Sunil that we having unwittingly gamified cost transparency for investors. Why? Prisoner’s Dilemma shows why two completely rational parties might not cooperate, even if it appears that it is in their best interests to do so. Take a fund investor and a fund manager, for example, or a politician and a regulator. The game was originally framed by Merrill Flood and Melvin Dresher in 1950. In it each prisoner was given the opportunity either to betray the other by testifying that the other committed the crime, or to cooperate with the other by remaining silent. The offer is:

The Prisoners Dilemma

● If A and B each betray the other, each of them serves two years in prison

● If A betrays B but B remains silent, A will be set free and B will serve three years in prison (and vice versa)

● If A and B both remain silent, both of them will only serve one year in prison (on the lesser charge)

Because betraying a partner offers a greater reward than cooperating with them, all purely rational self-interested prisoners will betray the other, meaning the only possible outcome for two purely rational prisoners is for them to betray each other]

Regulatory Overload - Confidence Game?

Historically, after a major stock market crash, new regulations are introduced en masse at the behest of politicians who are keen to be seen to be doing something to appease angry voters and, to prevent (naively) a repeat in the future.

Typically, there is a knee-jerk over reaction, with some of the new regulations proving over time to be punitive and potentially damaging to the system. As one risk is controlled; new risks emerge. State intervention and free markets have rarely co-existed well. Ultimately, regulators review the outcomes that the most punitive regulations have delivered and slowly roll-back, meaning that a long-term equilibrium is restored to help ensure proper cost-effective economic and social outcomes.

Since the credit crunch of 2008, European financial markets have experienced 10 years of prescriptive regulation – with no roll-back. It disintermediated the capital on the balance sheets of banks onto the balance sheets of asset managers. From defined benefit to defined contribution pension schemes. From plan sponsors (employers) to plan members (workers).

The UK’s approach of principles-based regulation has all but disappeared; replaced by prescriptive rules designed by bureaucrats who are keen to make a point – and make it badly – not realising that over-zealous regulation is damaging the European economy, industry and adversely impacting the economic and social outcomes of hundreds of millions of people with it. After all, aren’t these the very people that they were elected to protect? Whatever your persuasion, the politicisation of finance should not be welcomed by anyone, least of all the investor.

It seems odd then that whilst this ongoing slew of regulation has targeted financial services, the REAL risks have largely remained. Surely issues such as poorly capitalised EuroZone banks, Europe’s sovereign debt levels and debt trajectories, ongoing excessive trade surpluses, “relaxed” bank stress tests and the continual side-lining of the Euro’s “Golden Rules” are going to lead to far greater downsides for investors at some point, much greater than any impact from hidden costs and charges? Is the right problem being fixed?

Europe’s Financial Centres are fast becoming Compliance implementation centres. There has been little or no innovation since 2008 as management time and resources are spent on the implementation of regulation – and BREXIT. Firms now seem to have a resigned acceptance that they must spend these billions on new regulation, compliance and the remediation of previous non-compliance. The City of London, for one, has become a managerial-bureaucratic machine. Market conditions have improved so business continues on the same paths, with management focused on compliance there is little time or budget for adventure.

Without accuracy and consistency, the industry has struggled to deliver transparency that is simple and meaningful”. Financial Times - 30th January 2018

What exactly is the opportunity cost? And have outcomes matched the Cost Benefit Analysis that was undertaken by those in the European driving seat? I assume, of course, that there is a Cost Benefit Analysis somewhere and an ongoing process to monitor and correct imbalances? If not, then central banks would have better spent the money throwing it out of helicopters to workers to spend as economist Milton Friedman suggested in the 60s. Far better than Quantitative Easing, which since March 2009 has skewed asset markets, destroyed the purchasing power of cash savings, distorted fixed income markets, swelled the earnings of asset management (but not the returns of mass investors), driven vast capital into index products and widened the wealth divide. And what does this mean for new asset management firms wanting to enter the market and provide competition – with the barriers now ever higher, are their chances extremely limited?

The end result of this policy is that the manufacturing costs of financial products have likely risen exponentially over the last few years. They cannot have failed to do so, whether reported as such or not. Investors ultimately pick up this cost, which no doubt, has reduced expected returns even further in this volatile Central Bank-dominated environment.

Financial services firms doing business in Europe are already facing rising costs and falling revenues but now also face unquantifiable regulatory, reputational and monetary risks should they fall foul of the regulations. Given the volume and complexity of the current regulatory environment, and with more to come, it is only a matter of time before this happens. Given the rise of successful investor-driven litigation in the US, it won’t be long before it arrives in the UK and Europe. I can see lots of low-hanging fruit ripe for the picking.

Alongside the PRIIPs legislation, there has been a series of recent reforms in the investment product market at both domestic and EU level. Different legal and regulatory rule-sets apply to different types of investment products; there are different, and overlapping, disclosure requirements for manufacturers and distributors; and there are some differences in the timing, interaction and implementation of these various disclosure requirements.” FCA “Call for Input: PRIIPs Regulation – initial experiences with the new requirements” - July 2018

For investors looking at investment cost transparency from a financial centre perspective, it appears to me that that all are running at different speeds and in different directions. This gives rise to regulatory arbitrage for investors and asset managers. The UK, with BREXIT fast-approaching, may be about to adopt the highest transparency regime in the world. Transparency and tax avoidance have become synonymous since the ‘Panama Papers’.

There are two scenarios; a) the U.K. becomes a go-to destination for investors seeking higher transparency and protections outside (inside) the EEA trading area or b) becomes avoided by investors for the same reason. Then the U.K. becomes caught between satisfying EU passport rules (by gold-plating) and turnabout policy from the US as well as lingering US and EU tax avoidance regimes. A potential Fiduciary fly trap, slowly lured into transparency but ultimately trapped by it.

An example of gold-plating, the recent FCA Asset Management Market Study and follow-on remedies will push the boundaries out further than the EU by, for example, forcing UK Authorised Funds to remove box profits, removing “aspirational” fund benchmarks, introducing a requirement for independent non-executive directors on fund boards and by requiring an annual ongoing fund board declaration of “Assessment of Value” (similar to Value For Money) at the fund and share class level. This Assessment of Value will have to be made by the Chair of the Fund Board under the FCA’s Senior Management & Certification Regime (SMCR) meaning that the Chair becomes personally liable should this not be the case.

This means that UK Authorised Funds might become slightly more expensive (optically) than UCITS funds, but, if the industry gets it right, they could represent better Value for Money (or is it just Value?) for investors.

We should not forget that money (ignoring Crypto) is the most liquid and flexible form of asset. No King Canute-like form of regulation is going to stop it finding its most efficient home – it will find a workaround. In some respects, I welcome it.

The FCA Asset Management Market Study, Transaction Cost Disclosure In Workplace Pensions (PS17/20), MiFID II & PRIIPs

These are the 4 main regulations driving the majority of change around investment cost transparency at present. All are complex.

The FCA’s Transaction cost disclosure in workplace pensions (PS17/20 formerly CP16/30) paved the way for the slippage transaction cost calculation methodology now mandated by PRIIPs. Except the FCA made some sensible changes, mainly around implicit transaction costs for physical assets, which the EU is yet to adopt for PRIIPs. Financial services firms and investors are now faced with using two similar, but not identical, transaction cost calculation methodologies – and they may never converge.

The EU’s flagship regulatory initiatives, MiFID II (the re-cast Markets in Financial Instruments Directive) and PRIIPs (the Packaged Retail and Insurance-based Investment Products Regulation (PRIIPs), hit the market in January of this year. UCITS funds have a 2-year transitionary window before they too fall under PRIIPs.

Whilst well-intentioned, the application of PRIIPs to investment companies, a quintessentially UK-centric product, looks to be nothing short of hasty and ill-advised. I have written about this before so won’t dwell on the issues in detail here. The issues are related to the pre-requisite prescriptive cost, risk and performance metrics that are mandated to be reported on Key Information Documents (KIDs). Applying regulation intended for pooled fund products to an investment company, with an entirely different fund and capital structure, isn’t going to work. In fact, it hasn’t.

Investors run a high risk of being mislead should they follow the risk categories* or even the forward-looking performance projections. Why would anyone decide to project forwards based on what has happened over the last 5 years, especially when the last 5 years has seen markets in a bull phase?

*[JB on PRIIPS Risk: The Synthetic Risk Reward Indicator (SRRI) was first introduced for mutual funds based on a 7-bucket assumption of fixed band standard deviations. These assume that forward risk relates somehow to a previous 260-week period. Standard Deviation is not fixed but variable and any measure based on past returns tends to have an inverse relationship with forward risk. When low they induce risk taking; when high they induce risk avoidance. The irony that the EU criticised the use of such volatility-based measures, after the credit crunch, should not be lost on anyone.]

Similarly challenged is the new PRIIPs cost metric, the RIY (Reduction in Yield), which may not be treating debt-related cost items properly (i.e. there is a difference between asset-level gearing and fund-level gearing) and cost items related to the investment company capital structure (share buy-backs and corporate actions are two examples) have not been included.

For investment companies, the situation has been exacerbated by the fact that their main competitor products, Authorised Funds and UCITS (Undertakings for Collective Investments in Transferable Securities), aren’t covered by PRIIPs until the 31st December 2019. The 2-year transitionary window for UCITS funds allows UCITS to use their UCITS Key Investor Information Documents (KIIDs) along with the corresponding lower UCITS Ongoing Charges Figure (OCF). This means that investors will be comparing apples with oranges when comparing investment companies with UCITS until early January 2020. Investment company products may look appreciably more expensive than UCITS until the playing field is levelled.

Even now, 7 months post the PRIIPs live date, market participants have several scope issues, including certain corporate bonds with “make-whole” clauses and callable options, UK REITs and certain FX contracts. Even the FCA have expressed concerns about “changed behaviour” and that the regulations could be distorting markets leading to “unintended consequences”.

Late or no guidance on specific issues from regulators hasn’t helped, but let’s remember that local regulators, like the FCA, cannot give advice or an interpretation without recourse to Europe. Neither can local regulators unilaterally change the rules, even if they desperately need changing.

Serious consideration should be given to a complete re-write of the regulations – or an outright withdrawal. Perhaps an apology is in order too?

The other core regulatory initiative, MiFID II, also has open scope issues that may require further attention and resolution. Depending on who you talk to, some say that there is a prescriptive reporting format, and some say that there is not.

The FCA intends to review how both PRIIPs and MiFID II are working later this year. A call for input has already been made by the FCA with respect to PRIIPs.

To complicate matters further, rumours abound that 9 EU nations have not yet put MiFID II into law and, thus, may be a while away from achieving MiFID II compliance. Anecdotes around local exemptions are commonplace. Many financial services firms in EU countries, the UK included, are still either implementing or fine-tuning their MiFID II processes and cost disclosures. Furthermore, is it true that large continental European asset management groups are openly flouting transaction cost disclosure rules, thereby declaring transaction costs that are below those expected per the regulations and below those transaction costs being declared by competitors with similar products in other EU jurisdictions?

MiFID II is far less prescriptive with respect to slippage transaction cost calculation methodologies, with each methodology potentially outputting meaningfully different transaction costs. Together with the transaction cost calculation methodologies used by PRIIPs (the methodology preferred by asset management firms), I am aware of well over 10 different calculation methodologies in the market.

As asset management firms are not allowed to provide additional commentary on the MiFID II or PRIIPs KID, or to disagree with the outputs for that matter, investors are completely unaware as to how their transaction costs have been calculated. If they knew, they could ask pointed questions as part of their due diligence process to get to the reality. Gauging the quantum of missing transaction costs, if any, may be a step too far. There is also no universal agreement to quote the highest cost figure calculated, in the absence of which some risk of morale hazard arises.

Clearly, any asset management firm who purports to have played ball and is fully compliant with MiFID II is facing the fact that their products are seen to be expensive versus other local or EU-based competitors, who may not be fully compliant (and hence not be disclosing the appropriate level of costs) or who don’t have to disclose full costs for competitor products yet.

This, coupled with the ongoing staggered implementation approach means that who can necessarily blame firms for not wanting to be at a disadvantage that full and proper compliance with the regulations brings? The uneven, and somewhat unfair, playing field may point to some firms facing large competitive and, possibly, existential threats. This is not to infer that asset management firms, particularly those who Lord the U.K. Investment Association, are necessarily without blame but it is fair to state that not only asset management firms are culpable for the confusing state of affairs.

Rules are rules – and should be for all.

Given the uneven playing field when it comes to implementation, investors need to have an understanding of how good the various regulatory monitoring and enforcement regimes are across Europe. The rules are, in the main, exactly the same.

If there are EU member states who have not yet implemented MiFID II, which if true, is something that is not transparent to investors and perhaps to other market participants. What else is different, if anything?

Have different local interpretations of the rules been used by the various EU regulators and financial services firms? Are there different rule interpretations at individual Compliance Department level and, hence, at individual asset manager level too?

And, more importantly, what about local regulatory monitoring and enforcement? How even and fair is the playing field and will investors buying similar products in multiple European jurisdictions obtain the same outcomes? Has anyone checked? All differences MUST be in the public domain.

What happens to investors who have money being managed by non-European asset management firms in the US, Far East and in other parts of the world who do things differently? Will their cost transparency regulations and cost templates fit in with Europe’s? Unlikely – some jurisdictions don’t even have cost transparency template initiatives - and they can’t be forced to comply with European initiatives…..

Mountains of Lore

Retail Cost Disclosures

The retail investor segment (that’s you and I and our lifetime savings and pensions) is the one segment that is most at risk of adverse outcomes and, hence, requires the most transparency and protection. Research continually points to the fact that the man-in-the-street struggles to engage with their lifetime savings and pensions.

Having recently analysed the cost disclosure regimes on a number of retail investment platforms in some detail, why is it that investors are being short-changed as the Great Game is played out? A small number of the issues identified are mentioned below.

For a series of given popular funds at the top of fund buy-lists, one retail investment platform has 5 cost disclosures up on their web-site – with different costs shown on each disclosure. Some other platforms have made no attempt to provide MiFID II transaction costs to investors, meaning that an investor might choose an investment on one platform over another because it would appear, overall, that it is cheaper to buy it there.

And why have the output cost metrics from MiFID II KIDs and PRIIPs KIDs, the MiFID II OCF and the PRIIPs RIY, not been used on product FactSheets? Using much lower UCITS OCFs instead is somewhat misleading and is under-reporting costs for the consumer.

The point is: At this moment in time, how can any investor make an accurate Value for Money investment decision? The risks of making an incorrect investment decision have probably not ever been this high. The purpose of the regulations is to prevent this from happening, surely?

The Different Cloaks of Transparency

The cost transparency debate is near the top of all agendas, from governments and regulators down the chain to industry bodies, asset management groups and investors. With all of this focus, a positive outcome, a sure bet, is not far away, right? Think again.

Local UK and Europe-wide regulation has now become dangerously complex with differences in approach based on anything from fund jurisdiction, asset management segment, asset class, fund type, product type, investor type, EU member states et al. And don’t forget the current “transitionary regime” that lasts until 31st December 2019, after which it all changes again.

Even UK pensions have become subject to multiple different cost transparency regimes, whether workplace pensions, stakeholder pensions or DB (defined benefit), with some types of pensions better served than others. DB, which is currently ignored for the purposes of transaction costs, will see a solution soon, but will it match the others? Some initiatives do not even show the “member experience” of the impact of costs and charges on their pension pot, instead publishing costs and charges for default or certain core funds only.

Why take a different and piecemeal approach for each type of pension? It just confuses the public at large and the cost of compliance increases manufacturing costs. It also raises the issue of how regulators are going to monitor it all.

What about the UK’s Pensions Dashboard initiative that hopes to capture details of all pensions that an individual has? If the thorny issue of costs is to be managed, then how will members of different types of pension schemes get to grips with the reported costs, given the myriad of variables already mentioned, and the differing cost metrics? Simply aggregating all of the cost metrics together won’t work. It is likely to be highly mis-leading.

So, what are all of these cost metrics then?

The Cost Metrics Sweet Shop

Be advised to visit this sweetshop with an adult. An adult who, ideally, has visited it before, that is if they will go back in, that is.

“Welcome, Sir. What would you like today?”

“We have: TERs, Expense Ratios, AMCs, TCOs, TICs, Synthetic OCFs, UCITS OCFs, MIFID II OCFs, RIYs and much more besides…they’re all different, you know…”

“Level I or Level II, Sir?”

“And they all come with different flavours of transaction costs…”

“We even have over 10 different flavours of PTR…”

“And would you like them measured in monetary amounts, such as in Pounds Sterling or in Euros, or in percentages?”

“Not your bag, Sir? Then we have other offerings, but I couldn’t tell you much about them as they don’t have a name...”

“You’re not an institutional client? Well, it isn’t meant for you, Sir”.

Do you get the point? Caveat Emptor.


Entering this sweet shop won’t give you a sugar rush or much satisfaction. You are more likely to end up with indigestion or a headache as you may be in there for a few months tasting all of the delicious types of cost metric sweets. You may be out of pocket too as you may have to try everything in the sweet shop until you find the one that you like most. What are the ingredients used in these sweets or, more to the point, what ingredients have been omitted?

The choice of “sweets” available to measure transaction costs and investment costs is immense, but which one do you use – and for what type of investment? That is if all types of investment are covered that is. All of these cost metrics are incomplete – in different ways - and your average investor just won’t be aware. You just cannot add them all together to give you a total cost figure as it would be akin to mixing milk and orange juice.

In addition, many of the industry body-led investment cost transparency initiatives don’t even have a name for the output monetary amount or output percentage cost. How does this cost metric compare with all of the others? What exactly is the definition of “average NAV” and is everybody calculating it in the correct way?!

And if I am invested around the world in a plethora of different financial products, how do I easily get to a true initial and true ongoing cost figure for all of my investments? That one’s easy though – you can’t!

My advice to governance professionals is to adopt whatever transparency regime reports the highest costs and hope for the best. That can’t be right, can it?

New “zero expense” products – The Future?

Whilst Fidelity’s recent announcement about the launch of two new “zero expense” US index mutual funds is to be welcomed, they were widely reported by the Financial Times and other publications as being “zero cost” or “no-fee”.

“Zero expense” and “zero cost”/”no-fee” are two different things. Does the US “Expense Ratio” for US mutual funds capture all costs or, as I suspect, are certain costs missed? Time will tell as to how much they really cost, if anything, as a fuller understanding of how the products work develop.

With more and more asset management forms looking for alternative revenues due to upward cost and downward fee pressures, relying on stock lending revenues to keep fund costs down may prove to be an unsustainable business model.

After all, as more firms enter the stock lending arena and the supply of securities for lending increases, and with the EU’s SFTR regulation (Securities Financing Transactions Regulation) coming on stream in October of this year, revenues may come down and costs may go up.

If these new mutual funds are structured differently or are operating differently to Fidelity’s other US index mutual funds, then looking deeper may reveal more. Are costs moving from the funds themselves to the periphery and are we now going “off-template” with respect to cost transparency? I don’t know.

Time For Transparency On Investment Cost Transparency?

Despite the many well-meaning cost transparency initiatives, the various cloaks of transparency are serving only to further muddy the waters.

The removal of information symmetries to allow investors and governance professionals to do their jobs properly on a level playing field must, therefore, become a priority very soon before further damage is done to the investment cost transparency debate and trust in financial services drops further.

Going forwards, each investment cost transparency regime, whether regulatory or otherwise, should publish the following at a minimum. This is not an exhaustive list, however, as I am sure that you will have ideas too;

  1. Scope: What is explicitly in and out of scope? Is this a Level I or Level II costs initiative? What asset classes? Which markets/jurisdictions? Which types of investor does it apply to?
  2. Gap items – Which cost items are in scope and which are not? How many cost items have been included and excluded, in total?
  3. How any non-standard or contentious cost issues are handled?
  4. Is the regime compliant with MiFID II, PRIIPs and other relevant regulatory cost calculations? If not, where and how is it different?
  5. What slippage or other transaction calculation methodologies have been used and is this documented?
  6. A clear explanation should any funds or products exhibit negative transaction costs
  7. Have any issues been parked until a later version? What are they and when will they be covered? What is the quantum of costs involved
  8. Confidence level, in terms of completeness and accuracy
  9. Is there a comprehensive user manual for investors and governance bodies to refer to?
  10. Is there a mechanism for providing timely assistance on queries and issues?
  11. Is all information in the public domain?


This modern Great Game is best played with the long view in mind, and by not forgetting that our customer comes first.

The investment cost transparency debate has just boarded a Circle Line train with no final destination in mind. When the train does finally stop, investors and financial services firms might be too dizzy to realise where they are, what has happened and how long they were onboard. And what is the excess fare for such a long journey involving travelling around in circles?

This is not transparency, and neither is it cost-effective. A re-think is urgently required in the interests of ALL.

If Oliver Twist were alive, he certainly would NOT be asking for more.