If you've looked around this site you might have noticed that I usually hark on about total expense ratios (TERs) whenever mentioning fund charges. TERs are important, as they include not only a fund's annual management charge, but also running costs such as custodian and auditor fees which typically add 0.1% - 0.3% to annual charges.
However, TERs omit something that can have a far greater impact on overall annual costs - trading costs.
When a fund manager buys and sells shares the fund has to pay stamp duty and stockbroker commission, just like the rest of us. There'll also be a difference between the buying and selling price of the shares (a bid/offer spread) and a potential impact on the price of the shares if the manager is buying/selling a large amount - e.g. if the manager sells a large holding then dumping the shares on the market might reduce the price the manager can get.
Putting all these costs together, the total cost of selling shares in one company and buying some in another (i.e. a 'round trade') is likely to be around 1%.
||0.1% x 2 = 0.2%|
|Stamp duty (on purchases only)
||0.15% x 2 = 0.3%|
||0.05% x 2 = 0.1%|
The bid/offer spread and price impact is likely to be higher for smaller companies/less traded shares, potentially pushing the cost of a round trade to over 2%.
Given these are charges we'd pay to pay if buying and selling shares ourselves, should we be bothered? It all depends on the extent a fund manager trades and whether these trades make profits that more than outweigh the costs of doing so.
Check the portfolio turnover rate
The extent a manager trades is referred to a the annual 'portfolio turnover rate' (PTR). A PTR of 100% means the manager has effectively changed all the shares in the fund once over the year. A 25% PTR means a quarter of the fund has been changed once while a 200% PTR means all the fund has been changed twice.
Tracker funds tend to have lower PTRs than actively managed funds, although this depends on the index being tracked - indices with frequent re-weightings and changing constituents will have higher PTRs. For example, FTSE 100 tracker PTRs are typically in the 15%-20% range whereas FTSE 250 tracker PTRs are often over 50%.
By contrast, actively managed funds tend to have PTRs ranging from 50% to over 300%.
How do you find out a fund's PTR? Fund groups seldom publish these figures on factsheets, so you'll need to take a look at the fund's simplified prospectus. Schroders is better than most and publishes all their PTRs in a single list.
PTR figures are obviously historical and a fund will likely vary in future, but if a particular manager has a consistently high or low PTR, chances are they will in future too.
Does the manager profit from changing shares?
A high PTR is no bad thing if the manager profits from the trades. For example, the Blackrock European Dynamic fund has a PTR of 716% over the last year, probably dragging performance by around 7% due to dealing costs, yet it still comfortably beat the FTSE Europe (ex UK) Index by about 10%. Yes, the manager traded a lot, but it appears to have paid off.
But unsuccessful managers who trade a lot simply rub salt into investors' wounds - the UBS Equity Income fund had a PTR of 461% last year but remains a perennial underperformer.
Dealing costs are a worthwhile consideration when buying funds, but I don't think they should dictate your choice. As ever with costs, if a manager has the ability to outweigh charges with decent performance then there's little to worry about (albeit I do resent paying high charges!). But if you buy into a manager who tends to have a high PTR then just beware that it increases the potential for losses if the manager gets it wrong.