Spreads – Why they’re fair

When shopping around for funds to invest in. You’ll likely get to a point where progressing with a fund choice might come down to fees.

A common mistake we see investors making, when comparing Managed Funds side-by-side, is assuming that funds with buy and sell spreads (fees) are more expensive than funds without them.  In this article we explain why this isn’t true, and in fact, why buy and sell spreads help to stop investors experiencing hidden costs, and create transparency around fund fees.

Buy/sell spreads are transaction fees

When you buy or sell units in a fund, you may be charged a buy or sell spread, which is a fee.The buy spread (fee) is added on when you buy units, and the sell spread (fee) is deducted from the unit price when you sell units.  These fees represent costs incurred by the Fund Manager to process your buy or sell order.

The cost comes directly from the Fund Manager. When investors buy or sell units in a fund, the fund manager is obliged to buy or sell underlying securities e.g. shares, which inevitably triggers transaction costs (brokerage fees).

For the funds offered on InvestNow these buy/sell costs usually range from anywhere between 0.05% and 0.50%.

Funds that say they charge buy/sell spreads Vs. Funds that ‘don’t’

It’s important to remember, investors will incur buy/sell costs regardless of whether the fund says there is a buy/sell spread or not. The difference being;

  1. A fund that has buy/sell spreads, charges those transaction/brokerage fees directly to the investor that is buying or selling units in the fund.
  2. Funds that don’t have buy/sell spreads, allocate the transaction/brokerage fees across all investors in the fund.

This means funds that specifically reference buy/sell spreads up front in their PDS (Product Disclosure Statement – the document that provides you with essential information to help you decide whether to invest in a financial product) may look more expensive, in reality this isn’t the case. They are really just being more transparent with fees.

Funds that don’t have buy/sell spreads, could see you footing the bill for someone else’s activity and vice versa.

Global best-practice is to charge buy/sell spreads

Global best-practice is for funds to recoup these transaction costs directly from the actual investors investing in or divesting from the fund, via buy/sell spreads. This allows Fund Managers to apportion costs fairly without sacrificing returns for the investors who remain in the fund.

It’s all just a misunderstanding

Investors misunderstanding of buy/sell costs are evident in online forums, where people will often berate funds with spreads for being ‘more expensive’ than those without them.

Unfortunately, Fund Managers can take advantage of this misunderstanding by not communicating how the absence of buy/sell spreads can be a drag on performance while marketing their products as ‘cheaper’.

“NZ is still a bit of the ‘wild west’ when it comes to spreads, with many funds not having them,” .“To date, the regulator (the Financial Markets Authority) has not required managers to explain the negative effect of a fund not having spreads.” – Says Anthony Edmonds, founder of InvestNow.

“It seems odd that managers who have spreads must explain why these create equity amongst investors, while those without spreads never seem to disclose the potential inequities that this can create for investors.”

Meanwhile, Edmonds says fund investors need to be aware that buy/sell spreads are a sensible traffic management solution, not a roundabout way of charging unnecessary fees.

Buy/sell spreads provide transparency with fees. Transparency is a good thing.

Things to remember:

  • Funds with buy/sell spreads are being up front about their fees – you know what you’re getting and you’re only paying for your buying and selling activity.
  • Funds that don’t charge buy/sell spreads are still going to charge you those transaction fees, but they’ll be evenly distributed between all investors in the fund, potentially dragging down the performance of your investments.
  • Read the PDS for all fee details, include buy/sell spreads
  • Take a look at the buy/sell spreads for funds offered on InvestNow – includes a simple example showing the impact of these fees

 

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