Costs and
Active
and charges
passive investing
What key
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need
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successful
know investing
This guide has been produced for educational purposes only and should not be regarded as a substitute for investment
advice. Vanguard Asset Management, Limited only gives information on products and services and does not give investment
advice based on individual circumstances. If you have any questions related to your investment decision or the suitability or
appropriateness for you of the products described in this document, please contact your financial adviser.
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
2
While no one can control what happens in financial markets, you can control how
much you pay to invest in terms of costs and charges. They can have a significant
long-term impact on the performance of your investment so it’s worth taking
some time with your financial adviser to ensure you get the best deal.
This guide takes you through:
1
The role of costs and charges on long-term investing.
2
How costs compound over the long term, just like interest.
3
The role of costs in affecting fund manager’s performance.
4
The different types of fund manager charges and how fund managers deal
with them.
5
Transaction costs and how fund managers can deal with them.
6
A handy checklist of questions to go through with your adviser.
From reading this guide, you will understand the different types of costs and
charges that can affect your investments. You will also find out what kinds of
questions to ask your adviser to make sure you get the best deal possible.
1
3
The central role of costs and charges
4
The long-term power of costs
6
Costs and the zero sum game
8
Fund managers’ charges
10
Transaction costs
12
What next?
2
The central role of costs and charges
Charges, taxes and other
investment costs can
significantly erode the value
of your portfolio. A low-cost,
tax-efficient portfolio can be
the foundation for long-term
investment success.
Costs matter
Never underestimate the importance
of investment costs. Simply stated,
they erode your investment returns.
By keeping costs to a minimum, you
improve your potential returns.
Charges typically include an Annual
Management Charge (AMC) – this
covers the fund manager’s costs
of running a fund. Other ongoing
administration charges may include
audit fees, custody fees and other
operational expenses. Together all of
these costs make up the Ongoing
Charges Figure (OCF) of a fund.
Most funds have a OCF of around
1-2%. Other charges sometimes also
apply, such as an initial charge or a
redemption charge. There can also be
other hidden costs to look out for, as
these too can affect the performance
of your investment.
Annual Management Charge
(AMC)
The AMC covers the fund
manager’s costs of managing the
fund. It typically does not include
dealing costs or additional costs
such as audit fees.
Ongoing Charges Figure (OCF)
A figure for the total costs involved
in managing and operating an
investment fund. This includes the
Annual Management Charge (AMC)
which covers the fund manager’s
own costs of managing the fund,
as well as additional running costs,
including administration fees,
audit fees, custody fees and other
operational expenses.
3
The long-term power of costs
The differences in fund
charges can seem very small
and you might think that
paying 1.2% compared to
0.3% won’t make much of
a difference. But because
costs can compound, just like
interest, over the long term,
it can have a big impact.
4
How high fund costs can hurt
over the long term
Using a hypothetical example (which
does not represent any particular
investment), the graph illustrates the
potential impact of costs on a initial
investment of £10,000 over a 30
year period. This graph assumes 6%
average growth per annum which is
compounded year on year. As this
shows, a Ongoing Charges Figure
(OCF) of 0.3% compared to a OCF of
1.2% could potentially lead to savings
of £11,943 over a 30 year period.
Your financial adviser understands
the nature of investment costs and
can help ensure that your portfolio
is as cost effective as possible. It is
important to note that cost is not the
only factor. This example assumes
growth of 6%, however in reality
returns may vary and you may get a
lower return from a fund with higher
investment costs.
Growth of a £10,000 initial investment over a 30 year period,
assuming 6% growth per annum
£60,000
£52,749
Compound, compounding
Refers to when an asset
generates returns which are
reinvested and they generate their
own earnings. In this way you are
generating earnings from previous
earnings. The compounding effect
can be eroded by costs.
Hypothetical portfolio value
£50,000
£40,000
£30,000
£40,806
£20,000
£10,000
£0
1
3
5
7
9
11
13
15
17
19
21
23
25
27
29
30
Years
0.3%
0.6%
0.9%
1.2% Annual Management Charge
This hypothetical example assumes an investment of £10,000 over 30 years. Annual compounding is used for both
the assumption of 6% average growth per year and the investment costs. Costs are applied to average annual
growth of 6% for each year. As it is a hypothetical, this example does not represent any particular investment.
Source: Vanguard Asset Management
5
Costs and the zero sum game
A ‘zero sum’ game is one
in which there are equal
numbers of losers and
winners. Investment markets
can also be seen as a zero
sum game until you add in
costs. Then, there are more
losers than winners!
Investments and the zero
sum game
Any given investment market is a
‘zero-sum’ game. Academics use the
term ‘zero sum’ to describe a game
(or any other activity that can be
counted) where the overall outcome
always adds up to zero. Think of a
game of poker where each player
starts with a set amount in their pot.
When they stop playing, whatever
the outcome, the total amount that
has been won by all players summed
against the amount that has been lost
by all players will be zero.
In terms of the investment markets,
this simply means that relative to the
total performance of the UK stock
market for every winning invested
6
pound there is a losing one and if you
subtract the winners from the losers
you get to zero.
As a result, half of all pounds will
automatically be on the losing side.
Then, if you take account of costs –
and if the theory holds – a majority
of all pounds invested will fail to beat
the market index whether that return
is positive or negative. This happens
because every asset manager starts
out behind the index by the amount
they take out of your investment in
charges. They first have to beat the
index by that amount just to break
even. See our white paper The case
for index fund investing in the UK for
a discussion of the challenge fund
managers face in beating the market.
High costs and active
management
Active managers face a significant
handicap in the form of higher charges.
Surveys of the average cost of active
management show that total cost
charge comes in at an average of
1.46% per year.* So the average active
fund manager starts out 1.46% behind
the index before they even begin
to invest.
The total cost for the average index
manager in the UK, on the other hand,
is about 0.73%,* with some funds
coming in significantly less expensive
than that. Given that it’s so difficult for
anyone to beat the index over longer
periods such as five, ten or fifteen
years, costs become a significant factor
when working with a financial adviser
to make any investment decision.
Active investment management
or actively managed funds
An investment management
approach where the manager
selects securities from the
investment universe in line with the
fund’s investment objective. The
aim of an actively managed fund is
to beat, rather than simply match,
the return from a particular market
index or benchmark. A market
index measures the performance
of a particular sector or style of
a securities market which is an
example of a benchmark.
Index (passive) management
An investment management
approach that aims to closely
match returns of a specified market
index. An index fund may hold all
the securities in the particular index
or apply a mathematical model to
purchase a sample of securities
that will perform as closely as
possible to the index. Also referred
to as passive management.
*Source: Morningstar as at June 2015. Includes all funds
registered for sale in the UK.
7
Fund managers’ charges
How much a fund manager
charges can have a significant
impact on your investment
over the long term. You might
also want to ask questions
about how they charge and
whether it is transparent.
Annual Management Charge
(AMC)
When you invest with any fund
manager, you will have to pay some
running costs. These include an
Annual Management Charge (known
as the AMC) which covers the fund
manager’s costs of managing the fund
over the year.
Additional running costs
With most managers you will also
typically pay additional running costs
out of your investment. These usually
include administration fees, audit fees
(where an independent auditor checks
that all accounts are fair and honest),
custody fees (paid to a custodian to
safeguard the fund’s assets on behalf
of the fund’s investors) and other
operational expenses. The AMC, and
these additional running costs, make
up the fund’s Ongoing Charges Figure
(OCF).
Look to see if a fund has a large
difference between its AMC and OCF
and ask your adviser about this.
8
Initial charges and exit
charges
Commission, charges and
advisers
You might see something called an
‘initial charge’ when you invest with
some managers. This charge usually
does not go back to the fund, it goes
to the fund management company
and forms part of its profit. Some
managers also charge an exit fee
when you want to leave their funds.
You need to be aware of all of these
charges before you invest.
Historically, many advisers received
commission payments from fund
providers and these were typically paid
from a fund’s initial charge. However,
following the Retail Distribution
Review (or ‘RDR’), this practice has
been stopped. If you don’t understand
how you are paying for your adviser’s
time and expertise, please ask them
– they will be happy to explain their
charging structure to you.
For more information on the role of
the adviser and how to select one,
please see the guide in this series
title: Financial advisers: How they
can help.
9
Transaction costs
In addition to a fund
manager’s charges, there
are a number of underlying
costs that can hold back
the performance of your
investments.
How your investment is
affected
When an investor enters or exits a fund,
the fund manager has to buy or sell
underlying securities on their behalf.
Dealing in underlying securities such
as an equity or bond, usually incurs
transaction costs such as broker fees
(the cost of buying or selling a security
through brokers) and the bid-offer spread.
These costs can add up over time
detracting from a fund’s potential
returns. If the fund as a whole has to
absorb those costs, then it affects every
investor in the fund because those
costs are subtracted from the value of
their investment. In effect, all the fund’s
investors are paying for an individual
investor’s transaction.
10
Bid/offer spread
In this context we’re referring to
the difference between the buying
and selling (or offer and bid) price
of an underlying security, such as
an equity or bond. The size of the
spread is affected by factors such as
current trading volumes and market
conditions.
This works in the same way as
buying and selling currency when
you go on holiday. When you buy
currency, you buy it at a higher price
than someone who is selling that
currency. The difference between
the two is how the bank makes
money on the service. Institutions
called ‘market makers’ do exactly the
same thing with equities or bonds.
Stamp Duty Reserve Tax (SDRT) means that existing or long-term
Dilution levy
As investors trade in and out of a
fund, this can create expenses for
the fund as the fund manager has
to enter the markets to buy or sell
the underlying securities. In order
to cover these costs and ensure
that existing investors don’t suffer,
a dilution levy is applied to those
specific investors, reflecting
the value of these costs. The
proceeds of the levy goes into the
fund itself for the benefit of its
investors and are not retained by
the fund manager.
*The SDRT charge can sometimes be reduced by certain
offsets. Vanguard calculated that an entry fee of 0.40%
most closely represents the Funds’ new transaction costs.
Whenever UK equities are bought, or
in some instances, when the shares
of a UK fund investing in UK stocks are
redeemed for in kind consideration,
HM Revenue and Customs levies a tax
called Stamp Duty Reserve Tax. This tax
amounts to 0.50% of the value of the
transaction, and applies whether the
trade occurs in the UK or not. However,
Vanguard assesses an entry fee of
0.40%* of the value of the transaction to
the purchaser to cover the SDRT charge.
SDRT is not a dealing charge imposed
by the broker or fund manager but a selfassessed tax which applies to electronic
or ‘paperless’ transactions only.
It is the industry norm in the UK for the
fund to pay this tax for all transactions.
This can sometimes be unfair as it
investors can be disadvantaged in the
same way as other transaction costs.
It’s worth asking your financial adviser
how the fund manager they select deals
with SDRT.
Finding transparent
investments
Your adviser can locate those fund
managers that deal transparently
with transaction costs and make sure
that long-term fund investors are not
disadvantaged by the actions of others.
This can be done using certain types of
levies, such as a dilution levy or charging
SDRT up front, in order to offset the
transaction costs. These levies are
returned to the fund for the benefit of
the fund’s investors and aren’t kept by
the fund manager.
11
What next?
This guide covered
• The role of costs and charges
• How costs compound
• Costs and investment returns
• Different types of charges
• Transaction costs
12
Your financial adviser
can help
How much a fund management
company charges you to manage
your money, and how they deal with
other costs and charges can have a
significant impact on your investment.
It’s worth spending some time with
your financial adviser to understand
how all these costs and charges work,
to ensure you get a fair deal.
When you work with your financial
adviser to build your investment
portfolio you can ask about the fund
costs and they can help you fully
understand the cost of investing. The
checklist of cost-related questions on
the opposite page may help.
Fund cost checklist
You might want to ask your adviser to run a simple costs checklist like this one:
Are all investment costs made clear and shown separately in the fund documentation?
Which investment costs will I pay up front and which are paid ongoing by the fund?
Is Stamp Duty Reserve Tax (where applicable) collected from the individual investor making the transaction, or the fund?
How are the fund’s long-term investors protected from the affect of other investors’ dealing costs?
Are the fund’s running costs paid for by the Annual Management Charge, or the fund?
Does the fund’s cost represent real value for money?
13
Please be aware that Vanguard Asset Management, Limited only gives information on our products.
We cannot give advice based on individual circumstances. This is where the advice of a qualified
financial adviser can be crucial. If you have any questions related to your investment decision or the
suitability or appropriateness for you of the products or services described in this brochure, please
contact your financial adviser.
Connect with Vanguard™
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Client Services
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available Monday to Friday
from 09.00 to 17.00.
Important information
This guide is designed only for use by, and is directed only at persons resident in the UK. It is for educational purposes only. The information on this document does not constitute legal, tax, or investment
advice. You must not, therefore, rely on the content of this document when making any investment decisions. The material contained in this document is not to be regarded as an offer to buy or sell or the
solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the
person making the offer or solicitation is not qualified to do so.
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.
© 2015 Vanguard Asset Management, Limited. All rights reserved.
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