There’s an interesting philosophical question posed by the implementation of MiFID II about whether something exists only when it can be seen or known. The source of this rather “deep” enquiry? The funds of funds sector.
Funds of funds and multi-manager strategies have always prompted more interesting questions in regulation that their more straightforward equity/bond investing peers. We first came across the challenges they pose when we were building our Solvency II offering, a regulation which aimed for insurance companies to be able to drill down into the underlying assets they held in order to assess the risks they face. That was relatively straightforward when the fund was just invested in shares or bonds – the price and origin of the security should have been fairly easy to identify. However substitute instead a fund with its own list of underlying holdings, perhaps even some more funds in there, and suddenly we have this concept of look-through, the burden of having to peer through a fund, or series of funds, to find the eventual underlying holdings.
Look-through funnily enough seems to be the cause of our philosophical enquiry under MiFID II. Under the new regime’s product governance rules, funds have to be able to provide cost & charges data to their distributors so that clients can make an informed choice about what they purchase. For an investor, they’ll want to see the amount of money spent by a fund when buying in and out of securities – the transactions costs. And here’s the problem – how are you able to outline your transaction costs if you don’t know what they are? A fund that just invests directly into the market is able to list these things – a fund that invests in other funds has to rely on those funds to outline their lower-level transaction costs in order for the overarching fund to be able to calculate its own consolidated costs. Thus far, many funds of funds have struggled with this task.
In fairness to fund of funds and multi-manager strategies, they have been constrained in their ability to provide costs & charges look through, as most managers only provided the data in very late 2017 or early 2018. Thus the complete evaluation of costs & charges across all products will only become apparent towards the end of the first quarter of 2018.
But here comes the real issue; some funds of funds have in the early part of this year, instead of listing that this data was unknown, have instead declared zero transaction costs. This could constitute a serious problem, because theoretically an investor could plump for a product ostensibly because it keeps its transaction costs at zero as opposed to a product that lists higher charges.
Which bring us back to our philosophical issue? In the quads of Oxford it may make sense to say that if you can’t see it then it doesn’t exist. For those of us in the real financial world, if a charge exists then it exists – not being able to outline its magnitude makes it even more important. Our conclusion must be then that funds of funds need to ascertain their transactions charges, and fast.