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Pension funds forced to disclose hidden costs

Trading expenses to be published in January 2018

Pension funds forced to disclose hidden costs

Firms managing money on behalf of workplace pensions will be required to tell scheme administrators how much they’ve spent trading assets, according to new rules published today by City watchdog the Financial Conduct Authority (FCA).

Until now, fund managers have not been required to explain how much of investors’ money they’ve spent on making trades, despite these costs being a direct drag on investment returns.

Find out more: Are fund charges eating into your returns? – our guide to the impact of costs

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Problem portfolios

On numerous occasions, Which? Money research has identified pension funds with high rates of portfolio turnover – some even trade a value equivalent to the size of the fund itself over the course of a year – suggesting many managers fail to take a long term view on their portfolios.

When turnover is high, increased transactions costs make it harder for a fund to outperform.

Every time a fund manager trades they incur a cost – there is a fee for the parties conducting the trade, the spread between buying and selling prices, and the time out of the market while the trade is taking place (in which time share prices can move).

By not disclosing transaction costs, fund managers have been able to obscure under-performance resulting from overly-frequent trading.

Now, the FCA has said that managers will have to disclose transaction costs according to a certain method, whenever requested to do so by the people running defined contribution pension schemes – that is, schemes where an employee’s money is added to a larger investment pot.

According to the new rules, fund managers will have to disclose transaction costs using a ‘slippage cost’ methodology. The rules will not apply to funds outside defined contribution pension schemes.

Slippage cost explained

The slippage cost methodology measures the difference between the price of an asset (a share holding, for example) when a trade is executed and the price at the time the trade order was placed.

Developed in the 1980s as a way of assessing transaction costs, this method identifies the loss in value that occurs when a transaction takes place – from the consumer’s point of view.

Industry responds

The Investment Association (IA), the trade body for fund management firms, objected strongly to this methodology in its response to the FCA’s consultation.

It argues that the data required is difficult to source, that it wouldn’t produce the information desired, and that it could be hard to interpret by trustees who are trying to assess the value-for-money offered by the fund managers.

However, the FCA hit back saying the alternative approach suggested by the IA – an estimation of the bid-offer spread supplied by the fund managers – would rely entirely on the honesty of managers and could therefore tempt them to dishonestly change their estimates for their own benefit.

The new requirements come into effect from 3 January 2018.

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