Total Expense Ratios- a strategic tool for the adviser

Collective Investments has led the way in transparency and the recently launched Total Expense Ratios (TER) are a useful strategic tool for advisers providing information on actual portfolio costs.

TER's will increase adviser confidence in the industry, ensuring advisers can be confident in recommending products, while investors know costs are disclosed and they are receiving excellent value.

Popularity growing

This transparency, as well as excellent returns, are major factors in the current record flows into Collective Investments. If the offshore experience with TER's is repeated here, collective investments, which are already competitive, will become even more so as fees decline.

Debate on costs

One of the features of TER's is that they dramatically improve transparency in the area of performance fees (which will be shown separately) and layered fees. Highly relevant to the the ongoing national debate on costs, is the fact that published TER's for each fund are based on historical fact and not on forecasts.

Costs included

TER's, which are published quarterly, are defined as a measure of the portfolio's assets relinquished as operating costs. This figure is expressed as the daily average value of the portfolio.

The costs include management fees (including performance fees) and the VAT thereon; fixed operating costs such as custody and trustee fees, audit fees and bank charges; liquidity costs, net negative interest charges; and for investments in other funds, the weighted portion of the underlying portfolio TER (for fund of funds), upfront fees and exit fees.

Costs not included

TER's do exclude certain items, primarily related to costs outside of the fund, charged directly to the client. These are upfront fees (manager, adviser); client costs (e.g. bank charges); costs of other product layers, such as an RA, LISP or endowment; exit costs; and trading costs (in line with offshore practice).

Understanding the implications

TER's are standardised, providing a useful comparative fund guide, but it is important for advisers and analysts to grasp the implications.

A fund with a high TER may not be a poor investment – the higher expense ratio may reflect out performance, with additional costs incurred to achieve this performance. Smaller funds may also have higher TER's due to the lack of economies of scale, as will funds with multi layer fee structures. Advisers and investors should not use TER's as the sole basis for investment – there are many other factors to consider.

The fine print

TER's will be published in the media, audited financial statements, advertising, fact sheets, newsletters and on websites and will be provided to investors at the time of the initial investment. The usual TER statement will take the form of:

The Very Good Equity Fund Class A has a Total Expense Ratio (TER) of 2.79%. This means that, for the period from 1 October 2005 to 30 September 2006, 2.79% of the average Net Asset Value of the portfolio was incurred as charges, levies and fees. A higher TER ratio does not necessarily imply a poor return, nor does a low TER imply a good return.

The current TER cannot be regarded as an indication of future TER's. Inclusive in the TER of 2.79%, a performance fee of 1.25% of the Net Asset Value of the class of the portfolio was recovered.

Offshore TER's, such as active funds in the UK, have ranged from 0.8 - 3.22% with an average of 1.68% while balanced funds have varied from 0.6 - 4.17%. In the US, large cap equity fund TER's range from 0.7- 2.15% with an average of 0.92%.