Given the significance of life companies in the Irish investment market, new rules aimed at making it easier for savers and investors across Europe to shop around should be not just welcomed but rapturously embraced.
Unfortunately however, the Packaged Retail and Insurance-based Investment Products (PRIIPs) regulations, which promised much, have not quite delivered as much as had been hoped.
Investors need a handle on how much they are losing on fees and charges; and how much they might save by choosing another distributor. However, as Marc Westlake, managing director of PortfolioMetrix notes, "more disclosure doesn't necessarily help".
“It’s trying to shine a spotlight on an opaque charging structure, but it’s providing more disclosure than is useful for a consumer,” he says, adding that the new documents are also quite complex. “Four of us went through the documents, and we struggled to work our way through it. There is no way a lay person can understand them”.
Brendan Barr, head of investment solutions with Standard Life, goes so far as to say that the new regime may have the "opposite effect of making it harder and more confusing for people".
The new regulations may not be perfect but they do lay bare the charges and fees imposed on funds in a way we’ve never seen before. And for that investors should examine the new key investor documents (Kids) before investing.
Key investor documents
Introduced in January of this year, PRIIPs means providers of investments such as structured instruments, non-UCITS unitised funds, hedge funds, unit-linked insurance policies and with-profit products for sale in the European Union – though not pensions, UCITS funds and deposits which are excluded – have to publish key investor documents. These are up to three pages long, detailing what kind of a product it is, how risky it is, whether compensation might apply and what the associated costs are. These documents are also listed on life companies' websites, thus giving easy access to investors. The documents must be updated once a year.
And when it comes to costs, the new requirements are significant. Product providers must detail entry costs, exit costs, ongoing costs (such as trading and management costs) and performance fees.
Hallelujah, you might say. Finally we get a proper steer on just how much our investments are costing us and we can compare them with international norms.
Life companies have always been expected to give customers information on charges. Under Central Bank requirements, life insurers were already obliged to provide customers with a customer information notice when they purchased an investment product. This included a “reduction in yield” figure, which shows how much your return will be cut by charges and other costs.
However, the reduction-in-yield figure under the old customer information notice is slightly different to the new reduction-in-yield as calculated under PRIIPs. Until now, life companies were required only to disclose charges such as the annual management charge; now the figure must also include the 1 per cent Government levy and transaction costs involved in buying and selling the underlying assets, as well as reduced allocations, and any exit penalties.
While this information may have been available in a different way – Standard Life, for example, quoted the unit price of its funds inclusive of these charges – it has never been so readily identifiable.
Breaking down charges
So what do the new PRIIPs charges tell us?
In short, life companies are keeping more of your investments than you may have thought previously. As Irish Life says in a note to brokers of the new Kids: “There is no increase in the costs and charges incurred. What is changing are the costs and charges that are included in the Kid and disclosed to clients.”
So there you have it: the costs were always there, we just didn’t know about them until now.
Consider Irish Life’s MAPs 4 multi-asset fund, which displays a standard annual management charge of 0.9 per cent. However, the Kid document shows that charges for year seven (when no early encashment fees apply) are 2.2 per cent, or more than 100 per cent higher.
Some of the biggest changes are for property funds. As Irish Life notes: “For actively managed funds, costs will tend to be higher on the Kid due to the new transaction costs included in the Kid figures. This is particularly the case for property funds where the costs associated with buying and selling properties are especially high.”
Aviva's Irish property fund has an annual management charge of 1.25 per cent, but if you cash in the fund in the first year you'll face much steeper charges. Indeed, you'll face a reduction in yield of 10.49 per cent (based on a return of 6 per cent), or lose about €1,000 of an initial €10,000 investment.
This is due to a hefty early encashment charge of 5 per cent, plus further costs of more than 3.5 per cent, including the insurance levy of 1 per cent. Not only that, but even if you stay with the fund for the full term, you’ll still be losing 3.45 per cent a year – significantly more than the 1.25 per cent up-front charge you may have thought you were giving up.
Of course, just because a fund is expensive doesn't mean it's bad; as Westlake notes, quoting John Ruskin: "It's unwise to pay too much, but it's worse to pay too little." Provided, of course, that the investor is aware of the charges.
But, while it’s inarguably the case that the drain on your investment is higher than the annual management charge reflects, there are unfortunately a number of reasons why this Kid figure is not as accurate and therefore as helpful as it might otherwise have been.
For one, the reduction in yield on an investment is based on an expected return, which is usually given under the “moderate” scenario. The higher the returns achieved under this scenario, the higher the reduction in yield will be.
Another factor is the impact of commission. The Kid document under the new PRIIP rules requires fund providers to include commission charges. This ostensibly is a welcome move that can help inform consumers. “For too long, investors have thought that commission is paid by the life insurance company,” Westlake says. The problem is that this figure isn’t always accurate.
The Kids are typically based on the highest possible commission charges. A broker may be offered commission of 1 per cent on a certain product, but the adviser may not actually accept all of this rate, which means that the reduction in yield shown may be higher than the actual charges imposed on the client.
As commission charges are not shown separately, it can be difficult to ascertain the true impact.
Many life products have the potential to impose entry charges, or allocation rates but, in practice, many don’t in order to offer a more competitive product.
“Most of our clients are investing in our funds with no entry charges, and no exit charges as they remain invested for more than five years,” says Barr.
He also notes that life companies have interpreted this requirement on commission differently, “so we don’t have a level playing field for consumers and financial advisers to make cross company comparisons”.
One way around this is to consider the “wholesale” cost of a fund – ie without deductions for commissions, distribution costs, etc – which some fund managers publish in a supplementary information document (Sid). Standard Life suggests investors consider the reduction in yield on their Sid instead. For example, on its Synergy investment bond the reduction in yield will be 3.17-5.04 per cent (excluding encashment charges). But if you look at the “Sid” on the Myfolio Market 3 fund the charges are as low as 1.29 per cent.
But again, even this isn’t the full charge you might face, as some commission/distribution charges may apply.
What investors should find useful is the disclosure of early encashments imposed on investors leaving a fund before the recommended term. And these should make people think twice if they’re not going to stay in the product for the long term.
Cash in your aforementioned property fund with Aviva in year one, for example, and you’ll pay a penalty of 5 per cent.
“These early penalties protect the balance sheet of the insurance company. They’re taking the strain of those commissions,” says Westlake, noting that if the investor breaks the contract and is paid out early, the life insurance company has a way to recoup the commission paid out.
The new documents also require fund providers to give a projection on the return for a €10,000 lump sum, or €1,000 put in over a year to a regular saving product, under four scenarios: favourable, moderate, unfavourable and stress.
But how useful are these projections? For example, the future returns are modelled on actual performance data for the prior five years. And we all know the saying “past performance is no indicator of future performance”.
The use of projections means that if performance has been good over the previous five years the stress scenario won’t look too bad. If the performance has been bad, even the favourable scenario may not look great.
As Irish Life notes: “After periods of good returns, the projected values on the Kid will be higher than after periods of poor or negative returns.”
A report from the Society of Actuaries raised a concern last summer as to whether consumers would be able to understand the complexity of the volatility projections, and whether that could exacerbate “herd mentality” in bull and bear markets, given the tendency towards potentially overly bullish or bearish outlooks.
In addition, the new projections aren’t even comparable with projections shown by the life companies in their own documentation, which are calculated differently.
The rules have already had some unexpected consequences. A key requirement of the new rules is that, to sell a product in Europe, it must have an aforementioned Kid. For investment funds that are already domiciled in Europe, under the UCITS structure, this requirement will already have been fulfilled. Others, however, such as US listed exchange-traded funds (ETFs), including the SPDR Gold Trust and the Nasdaq Biotechnology Index Fund, are now required to comply with the rules. But many have not yet done so. In practice, this has meant that online stockbrokers such as De Giro and Davy have stopped selling certain foreign-listed ETFs derivatives and leveraged products in Europe.
What about MiFID?
It's not just life companies which might be charging you more than you think; separate EU Markets in Financial Instruments Directive (MiFID) regulations have shone a light on how much other fund managers are charging their customers. An analysis from FTFm and Lang Cat shows that many investors pay almost double the ongoing costs figure shown in many of the UK's most popular funds, due to the inclusion of transaction costs.
For example, a BlackRock iShares FTSE UK All Stocks Gilt exchange-traded fund has on ongoing costs figure of 20 basis points (0.2 of a percentage point) but when platform fees and transaction costs are included, this jumps to 75 basis points.
Similarly, low-cost fund provider Vanguard has an S&P 500 UCITS ETF which has an ongoing costs figure of just 0.07 per cent, which jumps to 0.22 per cent under MiFID II guidelines.