{sidebar id=24 align=left}There are at least 33 strategies funds can use to visibly lower their fees to enhance their competitiveness while still being exposed to the same underlying costs, he says. This has been made possible because the innovation and complexity of the funds management industry has outpaced the legislation governing disclosure.

Super funds’ ability to hide the real costs of their operations undercuts the federal Government’s aim to lower average member fees to 1 per cent: even if published fees are driven down to this level, other costs will still loom outside the figure in the product disclosure statement.

“You can make announcements about 1 per cent fees, but if the 1 per cent is really 1.5 per cent or 2 per cent, it becomes a bit meaningless,” Elvish says. Elvish points to a typical master custody arrangement to reveal an instance where true costs and published fees are not aligned.

The custodian earns revenue by providing services – safekeeping, settle- ment and reporting – in addition to capturing spreads on interest rates while managing cash and conducting foreign exchange transactions, and they can also take a share of the revenue earned from securities lending operations.

But judging by the published fees they receive, master custodians make money solely by providing services. These fees don’t account for the income earned from securities lending, cash and forex management, thereby misrepresenting the true cost of super funds’ business with master custodians.

This provides funds with an opportunity to publish low expenses for custodial services despite larger true costs.

Another accrual of indirect costs occurs when funds invest in index products with a zero management expense ratio.

The super fund pays no management fee, but any outperformance eked from the replication process – “the cream off the top of the product” – is pocketed by the manager, Elvish says.

“In this situation, the manager gets the fee from the process, but in a published sense they provide a zero-fee product.”

These indirect fees are earned in all aspects of a superannuation fund’s operations, including product design,

asset allocation, investment strategy, investment management, transition management, broker relationships and custodian arrangements, Elvish says.

The exclusion of indirect costs from fee statements is legally permitted because the enhanced fee disclosure regulations were written at a time when super funds ran simpler portfolios consisting of equity, fixed income and property managers.

Funds now implement far more complex investment strategies. They allocate to an array of managers across different asset classes, own assets directly, use various investment interests while custodians perform a range of functions beyond record keeping. Fee disclosure rules are now out of step with reality.