The investment costs map: Below-the-line costs

In my blog The investment costs map: where costs can occur in the investment process, I described where and when pension investment costs can occur. In this blog, the third in the mini series, I set out what costs can occur “below the line”.

Firstly, a few things to remember from the first blog. The “line” is where the unit price is calculated. Costs that are below the line are implicit in the unit price (i.e. they are deducted BEFORE the unit price is calculated and so they are invisible to the consumer) and will not be contractually specific. Also, costs have both quantum and duration – different amounts at different times.

The most commonly known below-the-line charges are transaction costs. These are applied when assets are bought, sold, borrowed or lent and can be “voluntary” or “involuntary”. Transaction charges, however, are not the only below-the-line costs.

  • Involuntary transaction costs: as mentioned above these are the costs incurred in buying, selling, borrowing or lending an asset. They can be involuntarily incurred because the manager is forced to trade by unmatched incoming and outgoing cash flow – for example, a large investor exits the fund and isn’t matched by a large incoming investor, forcing a sale of assets. Generally, involuntary transaction costs are borne by the disinvestor/investor causing the trade, as opposed to other investors. It’s important to know that there is not one transaction cost. There are, in fact, many. They can include foreign exchange costs, legal fees, bid-offer spreads, custody fees, ticket charges and tax. We think there are at least 46 transaction costs that could be incurred.
  • Voluntary transaction costs: these are the same as involuntary transaction costs, except that they are incurred because the manager has chosen to trade – for example, to sell one asset and use the proceeds to buy another. They are borne by all of the fund’s investors.   

Other below-the-line costs can be bunched together broadly under the heading of “asset ownership costs”. These include:

  • Custodian fees: recurring fees for the normal housework of holding an asset – collecting dividends, paying tax and so on...
  • Audit fees
  • Physical property related costs, including insurance, maintenance and rental default
  • Legal fees

Not all of these charges are always borne by the fund. In some cases the asset manager will pay them out of their assets. In other cases (and this is where it gets complicated) the manager has a below-the-line cost budget, with them paying the costs that go over budget.

Here’s what the map looks like with these costs built into it:

In the remainder of this mini-series of blogs I’ll cover:

  • DC-specific cost issues
  • The weaknesses in the transaction costs proposals


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