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Hidden transaction costs on cheap index trackers

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AppleCrumble
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Hidden transaction costs on cheap index trackers

#274247

Postby AppleCrumble » December 31st, 2019, 4:18 pm

I'm looking at investing in some of the iShares Equity Index funds, e.g. iShares UK Equity Index Fund (UK) D Acc, to construct my own cheap global tracker.

They appear to be cheap - the kiid for the UK one states its ongoing charges are just 0.05% pa.

However, looking at the Fees and Expenses section on Morningstar the actual fees are given as:

Ongoing cost 0.07
Transaction Fee 0.12
Distribution Fee 0.00
Performance Fee –
Management Fee 0.05

I understand that the ongoing cost includes the management fee but what are the transaction fees? How often are they charged?

Lootman
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Re: Hidden transaction costs on cheap index trackers

#274251

Postby Lootman » December 31st, 2019, 4:40 pm

I believe that "transaction fees" include things like the cost of trading the underlying securities, i.e. commissions, spreads and (for UK funds) stamp duty. There are various other costs involved in running a fund on top of the management fee, which is the revenue the manager takes from the assets, usually monthly.

With index funds the clearest indicator of costs is the tracking error, because that reflects both any and all frictional costs and the accuracy of their tracking methodology. At least for the trackers I have looked at, the tracking error is very low. Some trackers are now approaching zero costs, especially if there is share lending revenues.

For active funds it can be more murky to determine the costs and expenses.

mc2fool
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Re: Hidden transaction costs on cheap index trackers

#274253

Postby mc2fool » December 31st, 2019, 4:43 pm

AppleCrumble wrote:I understand that the ongoing cost includes the management fee but what are the transaction fees? How often are they charged?

They are just that, the costs of transactions within the fund, i.e. the cost of buying and selling the stocks that make up the fund; their broker's dealing fees, stamp duty, etc.

For some bizarre reason, when the powers that be mandated what was to be included in the Ongoing Charges Figure that collective investments must publish, they decided not to include the funds internal dealing costs.....

AppleCrumble
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Re: Hidden transaction costs on cheap index trackers

#274256

Postby AppleCrumble » December 31st, 2019, 4:55 pm

mc2fool wrote:
AppleCrumble wrote:I understand that the ongoing cost includes the management fee but what are the transaction fees? How often are they charged?

They are just that, the costs of transactions within the fund, i.e. the cost of buying and selling the stocks that make up the fund; their broker's dealing fees, stamp duty, etc.

For some bizarre reason, when the powers that be mandated what was to be included in the Ongoing Charges Figure that collective investments must publish, they decided not to include the funds internal dealing costs.....


Do you know if the figure given is likely to be the annual charge like the OCF is?

mc2fool
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Re: Hidden transaction costs on cheap index trackers

#274257

Postby mc2fool » December 31st, 2019, 4:56 pm

AppleCrumble wrote:
mc2fool wrote:
AppleCrumble wrote:I understand that the ongoing cost includes the management fee but what are the transaction fees? How often are they charged?

They are just that, the costs of transactions within the fund, i.e. the cost of buying and selling the stocks that make up the fund; their broker's dealing fees, stamp duty, etc.

For some bizarre reason, when the powers that be mandated what was to be included in the Ongoing Charges Figure that collective investments must publish, they decided not to include the funds internal dealing costs.....


Do you know if the figure given is likely to be the annual charge like the OCF is?

Yes, it's a %p.a. figure.

nmdhqbc
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Re: Hidden transaction costs on cheap index trackers

#274265

Postby nmdhqbc » December 31st, 2019, 5:15 pm

AppleCrumble wrote:They appear to be cheap


I just notice that on the morningstar website is has 31DEC19 NAV as 242.3. On Trustnet (linked below) it shows as Bid/Offer price: 242.30p/243.60p (31/12/2019). I make that just above a 0.5% difference between the buy and the sell price.
https://www.trustnet.com/factsheets/o/g ... y-index-uk

Maybe have a look at Vanguard FTSE U.K. All Share Index Unit Trust Accumulation below. Slightly higher ongoing charge (0.06%) but no bid offer spread and seems to have lower transaction fees. Seems like that the transaction fees would vary year to year though so next year vanguards might be higher than iShares for all we know.
https://www.morningstar.co.uk/uk/funds/ ... LWVH&tab=5
https://www.trustnet.com/factsheets/o/h ... hare-index

AppleCrumble
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Re: Hidden transaction costs on cheap index trackers

#274266

Postby AppleCrumble » December 31st, 2019, 5:16 pm

Lootman wrote:
With index funds the clearest indicator of costs is the tracking error, because that reflects both any and all frictional costs and the accuracy of their tracking methodology. At least for the trackers I have looked at, the tracking error is very low. Some trackers are now approaching zero costs, especially if there is share lending revenues.


Is tracking error how close the returns are to the benchmark?

E.g. for iShares UK Equity Index Fund (UK) D Acc

Total Return (%)

-2.91 16.48 12.62 5.89 2.65

Benchmark (%) Index

-2.81 16.41 12.59 5.78 2.68

What is a typical 'low' tracking error? <0.1?

AppleCrumble
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Re: Hidden transaction costs on cheap index trackers

#274269

Postby AppleCrumble » December 31st, 2019, 5:25 pm

nmdhqbc wrote:
AppleCrumble wrote:They appear to be cheap


I just notice that on the morningstar website is has 31DEC19 NAV as 242.3. On Trustnet (linked below) it shows as Bid/Offer price: 242.30p/243.60p (31/12/2019). I make that just above a 0.5% difference between the buy and the sell price.
https://www.trustnet.com/factsheets/o/g ... y-index-uk

Maybe have a look at Vanguard FTSE U.K. All Share Index Unit Trust Accumulation below. Slightly higher ongoing charge (0.06%) but no bid offer spread and seems to have lower transaction fees. Seems like that the transaction fees would vary year to year though so next year vanguards might be higher than iShares for all we know.
https://www.morningstar.co.uk/uk/funds/ ... LWVH&tab=5
https://www.trustnet.com/factsheets/o/h ... hare-index


Seems to be more complex than I first thought. Articles about cheap index trackers such as this one don't tell the whole story.

Lootman
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Re: Hidden transaction costs on cheap index trackers

#274271

Postby Lootman » December 31st, 2019, 5:27 pm

AppleCrumble wrote:
Lootman wrote:With index funds the clearest indicator of costs is the tracking error, because that reflects both any and all frictional costs and the accuracy of their tracking methodology. At least for the trackers I have looked at, the tracking error is very low. Some trackers are now approaching zero costs, especially if there is share lending revenues.

Is tracking error how close the returns are to the benchmark?

What is a typical 'low' tracking error? <0.1?

Essentially yes. It shows the deviation from the underlying index. An index is a theoretical construct and so has no costs. Therefore an index fund should always have a lag and return slightly less than its index. That lag is called the tracking error and it's really the only number you need to look at in my view.

I've seen cases where an index fund actually beats its index, i.e. has a negative tracking error. This might be because delays in adjusting for an index constituent change actually benefits the return. Or there may be share lending revenues that are higher than the lag. Back when I worked for an index fund provider we were told that it is better to under-perform the index by 5 basis points than out-perform it by 10 basis points. Because the issue is fidelity to the benchmark and not trying to beat it by second guessing it or engaging in tricks.

And yes, personally I'd regard a tracking error of 10 basis points or less as satisfactory. Some ETFs do better than that.

AppleCrumble
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Re: Hidden transaction costs on cheap index trackers

#274277

Postby AppleCrumble » December 31st, 2019, 5:48 pm

mc2fool wrote:For some bizarre reason, when the powers that be mandated what was to be included in the Ongoing Charges Figure that collective investments must publish, they decided not to include the funds internal dealing costs.....


Interestingly on this Blackrock page for the iShares Core MSCI World UCITS ETF this info is given for the OCF:

Ongoing Charges Figure (OCF)- this is a measure of the total costs associated with managing and operating an investment fund. These costs consist primarily of management fees and other expenses such as trustee, custody, transaction and registration fees and other operating expenses. The total cost for the fund is divided by the fund’s total assets and expressed as a percentage which represents the OCF.

Perhaps they're referring to different transaction fees.

GeoffF100
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Re: Hidden transaction costs on cheap index trackers

#274298

Postby GeoffF100 » December 31st, 2019, 8:03 pm

Unfortunately the regulations are unhelpful here:

https://www.vanguardinvestor.co.uk/arti ... nd-charges

MiFID II introduces the idea of a Total Cost of Investing (TCI) in a fund, which incorporates four main elements:

1. The fund's ongoing charges, which include all the recurring charges related to the fund, such as management fees, service costs and custody fees.

2. Transaction costs, which are the costs that the fund incurs when it buys and sells underlying investments, such as broker commissions and stamp duty reserve tax.

3. One-off charges, which are any charges paid to the fund provider at the beginning or end of the investment, such as initial charges, exit fees, etc. At Vanguard, we don't charge these fees.

4. Incidental costs, such as performance fees. Again, Vanguard does not charge these fees.
You need to bear two important caveats in mind when you think about the TCI.

First, the regulators have allowed fund providers to use several different methods to calculate their funds' transaction costs. Different providers are likely to use varying calculations, making comparisons between providers meaningless.

The second caveat is that, in practice, to access any provider's funds you will also need to pay a platform or account fee.


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