INVESTMENT costs among Singapore's retail funds remain stubbornly high, exacting a substantial toll in terms of net returns for investors.
But in a funds landscape dominated by distributors such as banks and insurance companies, the overall picture is unlikely to change much - unless regulation intervenes, as it has across markets in UK, Australia and Europe, which have taken a hard line on "inducements" to fund sales.
In Singapore, fund sellers are remunerated not only through an upfront sales charge, but also through a share of the trail fee - that is, the portion of the annual management fee the fund pays out to distributors. The annual management fee accounts for the bulk of a fund's total expense ratio (TER); the sales charge is not included in the TER calculation. While sales charges have been coming down thanks to growth in portfolio services and greater penetration of online transactions, the trail fee is coveted because it is recurring.
TERs are a drag on investment returns. A fund that pays no trails will effectively deliver higher net returns. New entrant Dimensional Fund Advisors' (DFA) funds, for instance, pay no trails and have TERs of between 0.32 and 0.38 per cent. Equity funds' TERs easily exceed 2 per cent.
Equity funds typically pay distributors half of their annual management fee as trail fees. But larger banks could command as much as 60 per cent, according to sources.
Banks and insurance companies may not share the trail fees with their representatives. But among financial advisory (FA) firms, the parties in the distribution food chain get a share. Platforms like iFast collect the trail fee and retain a cut - reportedly as much as half, depending on negotiations with FAs - before passing it on to advisers on the platform. This is in addition to an annual platform fee of between 0.2 and 0.3 per cent that they receive from end-investors.
The upshot of all this is that retail investors are stuck with intractably high costs. And, lower cost funds which pay little or no trails struggle to raise assets.
This distributor-skewed dynamic raises questions about how the CPF's plans for the so-called Lifetime Retirement Investment Scheme would take off, because there may be little to pay distributors, if at all. LRIS was proposed in 2016, and is envisioned as a low cost option invested mainly in passive diversified instruments.
Already the CPF Investment Scheme's plan to slash fund sales charges to zero, and advisory wrap fees to 0.4 per cent, has been delayed to October 2020 instead of October this year, "in response to industry feedback that financial advisors require more time to adjust to the revised CPFIS fees structure".
This landscape creates a painful and persistent quandary for investors, whether they are aware of it or care about it or not. First, the cash funds marketplace is dominated by high-cost funds because their fees offer enough cushion to incentivise sales.
Second, trail fees create a potential mis-alignment of interests. While they are part of the routine disclosures that distributors must comply with, there is little visibility on the varying proportions that the sellers or advisers are able to negotiate as their share. More aggressive fund firms will pay larger trails. A lot depends too on the negotiating clout of the distributor. How would an investor know if a recommended fund is actually best-in-class, or the one paying the highest trail?
In Europe, transparency and unbundling of costs and inducements such as trail fees are being forced by the MiFID II framework which came into effect last year, aimed at enhancing investor protection. While details of implementation may vary by jurisdiction, the basic implication is that under MiFID rules dealing with European intermediaries, trailer fees are considered inducements and are forbidden or restricted. Most funds distributed in Singapore are domiciled in Luxembourg or Dublin and must be MiFID II-compliant. But distributors and investors in Singapore are non-European and hence exempt from the rules on intermediaries.
Still, there are insights to be gleaned in terms of best practice when it comes to the potential for conflicts of interest, and the legal standing of investors. In Switzerland in particular, a landmark ruling should make distributors here sit up. A civil case was filed in 2012 against UBS, where a client made a claim for the retrocessions (fee-sharing arrangements such as commissions and trail fees) that the bank received. The Swiss Federal Supreme Court ruled in the client's favour and ordered UBS to refund the fees with retroactive effect. A paper by Deloitte Consulting pointed out: "The judgment makes it clear that investors are entitled to all commissions and/or retrocessions that banks receive from funds.''
Code of conduct
What this judgement underscores is that trail fees are ultimately a cost borne by investors. Particularly for investors in wrap portfolio accounts that already charge an annual advisory fee, the trails and other similar commissions should be rebated back to investors' accounts. Interestingly, this is already part of the code of conduct for private banks here since 2017. Ironically, there is no such code for retail investors who arguably need protection more.
According to the code, a private bank offering discretionary portfolio services should not receive or retain any retrocessions from product providers if they charge a management or advisory fee. If the bank receives a retrocession it should adjust the advisory fee or rebate the retrocession to clients.
This is why private banks' discretionary portfolios are likely invested in institutional or "clean-fee" share classes of funds with no trail fees. In Singapore, UBS this year made its Advice platform retrocession-free. Credit Suisse says its discretionary portfolios are retrocession-free. Even its advisory solution "Credit Suisse Invest" is retrocession-free.
This is not typically so for retail investors. Those in portfolio services run by FA firms generally do not get the trails back, even though they pay an annual advisory fee of an average 1 to 1.2 per cent.
Portfolio services by MoneyOwl, Providend and Endowus do not levy sales charges nor retain any commissions or trails. The firms' portfolios invest in DFA funds which are only sold through FAs. Endowus may also allocate portfolios to funds with institutional or "clean-fee" share classes that do not pay trails.
Lion Global Investors last year launched an actively managed multi-asset fund - the LG All Seasons Fund - whose TER is 0.5 per cent. The fund has so far gained some traction with S$44 million in assets. LGI is also understood to be looking into CPFIS inclusion for its Infinity range of funds, which invest in Vanguard index funds, and may review the Infinity funds' TERs. The Infinity US 500 Stock Index fund has a management fee of 0.475 per cent, compared to the underlying Vanguard US 500 Stock Index Fund's ongoing charge of 0.25 per cent (non-institutional share class).
Meanwhile, data from Morningstar Direct show nearly 40 fund categories whose average net expense ratio exceeds 2 per cent. These include popular categories such as Asia ex-Japan equity funds (2.18 per cent); global small cap equity (2.41 per cent); and more specialised categories such as biotechnology equity with a staggering 3.12 per cent).
The CPFIS does its part to rein in costs. Among a number of criteria, funds must comply with the CPFIS cap on TERs in order to be able to accept new CPF monies. The TER cap for equity funds, for instance, is 1.7 per cent.
At end-2018, there were a total of 42 unit trusts and investment-linked funds (ILPs) on the so-called List B that are unable to take in new CPF monies. Excessively high TERs are not the only reason to be barred from new CPF sales. As this writer understands, some funds may actually meet the required criteria but choose to remain on List B.
A number of fund firms subsidise their funds' expenses to comply with the TER caps. Aberdeen Standard, for example, began to subsidise fund expenses in 2015. It subsidises the expenses of 11 funds, reflecting "our commitment to remain in the (CPFIS), and to protect the interest of investors".
Franklin Templeton also created a new "AS" share class for six funds, with reduced management fees. There are, however, another five FT funds on List B as at March, whose TERs range between 1.82 and 2.49 per cent.