In a short newsletter entitled ‘Now You Fee It, Now You Don’t’, Brett Elvish, from consultancy Financial Viewpoint, looks inside the realm of undisclosed costs within the superannuation and funds management industry. He finds that in some cases, published fees within the investment industry – for functions ranging from master custody to fund of hedge funds (hedge FoF) investments – are just the tip of the true costs iceberg. The Treasury’s Enhanced Fee Disclosure Regulations of 2005 are not helping the situation, Elvish says. “Not so long ago funds would appoint a small number of equity, fixed interest and property managers. Investments would be primarily via simple instruments (e.g. shares, fixed coupon bonds), and a custodian would help with the record keeping. The Enhanced Fee Disclosure regulations were designed with this relatively simple world in mind,” the consultant points out.
“Today, funds are investing with a large number of managers, managing investments directly, engaging investment banks, using a diverse range of investment instruments and structures, with a custodian providing a broad array of services. The regulations are now out of step with the “normal” investment arrangements of most funds.” The investment industry is largely content to let the bulk of these undisclosed costs remain in the dark, since they are not required to report them under the current fee disclosure rules. However, some companies are more forthcoming than others and acknowledge some of these costs in their published fees. Competitors who aren’t so open have the opportunity to gain a marketing edge because their fees seem lower. “There is a myriad of different ways in which people manage their costs, resulting in published costs being misleading,” Elvish says. “There are an enormous range of costs that don’t get disclosed, like brokerage. They don’t get reported in the cost structure and don’t get disclosed to the [super fund] member.”
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, settlement 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.
