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Finch, Nigel; Ford, Guy --- "New fee framework (Financial services - funds management expense ratios)" [2007] MonashBusRw 7; (2007) 3(1) Monash Business Review 32

New fee framework
(Financial services – funds management expense ratios)

Nigel Finch, Guy Ford

Nigel Finch and Guy Ford discover some distortions in the calculation of fund management expense ratios and propose a new approach.

Investment funds under management (FUM) in Australia will grow on average 12 per cent per annum to around $2.99 billion by 2014, driven one-quarter by net inflows and three-quarters by investment performance, according to financial services information group, Rainmaker.

Investors are sensitive to fees – higher fees will impact on their investment returns – and they use expense ratios, such as the management expense \ratio (MER), as aids to compare the costs of different investment fund.

Many attempts have been made to reform Australian fee disclosure over the past few years with some staggered amendments to the Corporations Regulations produced during 2005 and 2006. These reforms are intended to improve the disclosure of fees in product disclosure statements (PDS). However, they are not systematically addressing all the issues that affect the reliability of MER as a useful disclosure across the entire industry.

In a study of 50 investment and superannuation funds in Australia, we identified as many as 17 multi-variant fee types charged during the investor’s life-cycle of investment, retention and redemption, and determined four significant problems undermining the reliability of expense ratios and hence limiting their usefulness for investment decision-making:

• Ambiguity in the way in which fees are classified leading to inconsistencies between investment fund disclosures (e.g. performance fees, termination fees)

• Inconsistencies between investment funds in the disclosure of taxation expenses (e.g. before-tax basis or after-tax basis)

• Inconsistencies in the way assets are valued when calculating the expense ratio (e.g. gross assets versus net assets, average assets versus actual assets)

• Distortions in the MER disclosure where actual assets are used because of differences in the frequency of fee calculation and growth in FUM over the period, as identified in the growth distortion model (GDM).

A fund which calculates the MER using an actual asset valuation, rather than an average asset valuation, may achieve a competitive and/or price advantage over similar funds, and this advantage may be amplified where the fund achieves positive growth in FUM. Investors who rely on the MER to interpret the magnitude of fees in these funds will be misled, as the disclosure will be grossly understated.

To overcome this problem, we developed the GDM, which is useful for investors to compare the MER disclosure of a fund using actual asset valuations with a fund using average asset valuations. The GDM is also useful for those funds which use actual asset valuations to adjust the fee accrual in the fund to take account of FUM growth and the periodicity of fee calculation.

A new framework for fee disclosure

We also propose the performance cost ratio (PCR) as an alternative approach to fee disclosure which is designed to overcome the deficiencies identified in the MER (see full paper for PCR equation). The PCR removes ambiguity in the way fees are classified by including all expenses paid or payable. The PCR recognises both total expenses and investment performance on an actual after-tax basis, which allows for uniform comparison between investment funds. The PCR avoids any of the inconsistencies in measuring asset values by removing this measure, and by ignoring the periodicity of fee calculations, the PCR is not affected by the distortions identified in the GDM.

As many as 17 unique fee types apply to Australian investment funds. They are charged as either a percentage or a flat dollar amount and they may be levied on a one-time, recurring or per transaction basis They may be charged to the account of an individual investor or levied against the investment fund as a whole. Investment funds levy different combinations of these fee types and not all fee types are used by all investment funds. Also, the nomenclature of the fee type changes between investment funds but the intention of the fee is the same.

Access to the full academic paper

MBR subscribers: To view the full academic paper email mbr@buseco.monash.edu.au.

Public access: www.mbr.monash.edu/full-papers.php (six months embargo applies).

Cite this article as

Finch, Nigel; Ford, Guy. 'New fee framework'. Monash Business Review. 2007.; Monash University ePress: Victoria, Australia. http://www.epress.monash.edu.au/. : 32–33. DOI:10.2104/mbr07007

About the authors

Nigel Finch

Lecturer in Management at the Macquarie Graduate School of Management.

Guy Ford

Associate Professor in Management at the Macquarie Graduate School of Management.


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