Investment charges explained
Initial charges are taken from your money before it is invested. The majority is paid in commission to the adviser from whom you bought the fund. Your adviser may refund some, or all, of their initial commission in a so-called 'rebate'. It is increasingly common for funds to have no initial charges. Also, there are sometimes exit charges, but these are rare.
ONGOING CHARGES FIGURE (OCF)
This is the new term for the total expense ratio (TER) and it gives the most accurate measure of what it costs to invest in a fund. The OCF is made up of the annual management charge (AMC) and other operating costs.
The AMC is levied by the manager and is used to pay the investment manager, financial adviser, fund accountant, administrator and distributor. Other operating costs include those for extra services paid for by the fund, such as the fees paid to the trustee (or depositary), auditor and regulator.
Stamp duty is the biggest of these costs. It is not part of the OCF and is disclosed separately in funds’ annual reports and accounts.
Total trading costs cannot be compared in a meaningful way because the markets for different types of asset operate in different ways.
These reward the investment manager for superior returns or outperforming expectations. There are about 90 open-ended funds in the UK charging performance fees, up from 34 at the end of 2007, according to research by Lipper.
However, Ed Moisson, head of UK research at Lipper, believes they should generally be avoided. "Unless you’re willing to do your homework in order to understand how they kick in and how high they can be, I’d be careful about investing in funds with performance fees," he explains.
"You don’t get money paid back if they underperform, while the management fee will generally be set at the same level as those that don’t have performance fees."
Total expense ratio
Most investment funds levy an initial charge for buying the units/shares and an annual management fee but other expenses also occur in running the fund (trading fees, legal fees, auditor fees, stamp duty and other operational expenses) which are passed on to the investor and so the TER gives a more accurate measure of the total costs of investing. The TER is especially relevant for funds of funds that have several layers of charges. Unfortunately, investment fund companies are not obliged to reveal TERs and many only publish the initial charges and annual management charge (AMC).
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Annual management charge
If you put money in an investment or pension fund, you’ll not only pay a fee when you initially invest (see Allocation Rate) but also a fee every year based on a percentage of the money the fund manages on your behalf. Known as the AMC, the actual percentage varies according to the particular fund, but the industry average for active managed funds is 1.5%.
Usually charged as a percentage of returns for performance above a specified benchmark, such as an index. The fee can range from 10% to 20% of total investment returns on a low starting benchmark such as Libor and investors could find themselves paying extra fees for merely average performance. Note that these funds do not compensate investors when the manager underperforms the benchmark.