The Belly of the Beast

In high summer last year, the Investment Association (IA) published its infamous paper which made the preposterous claim that there were no hidden costs or charges associated with asset management, that these were the "Loch Ness monster" of finance. At the time, I wrote that it seemed to me that if the Investment Association had been swallowed whole by that monster, and lay decomposing in the belly of this beast, they might be expected to present that situation as the location, capture and domestication of the beast.

Recently I have been hearing rumblings, emanations from within the beast, to the effect that the problems of cost and fee disclosure were solved long ago by the Investment Association, that the work of the Financial Conduct Authority and the Department for Work and Pensions on disclosure templates is redundant, unnecessary and a waste of time and money.

The Investment Association has indeed published sets of proposals, which are too extensive to discuss fully in a short article. However, there is one metric, their proposed portfolio turnover ratio, which illustrates the failings of the IA's proposals rather well.

This is the lower of purchases or sales divided by the average assets outstanding in the measured period. This measure is patently nonsensical. If we were to become bearish at a point in time and sell all of the fund's assets, while buying none, the reported turnover (and transaction costs) would be zero. Similar results apply on the bullish side. There is also the question of the stability of the statistic over time as the numerator switches from purchases to sales and vice versa. Simply put this metric is not fit for any purpose.

I know that it is mandated by the Securities Exchange Commission within the US, but as with all too much American, that just reflects the unbridled power of a monied special interest lobby group.

Use of this statistic in further analysis can result in some very strange empirical 'findings', such as: active mutual funds perform better after trading more and this effect is especially strong for small, high-fee funds.

We have long been accustomed, and perhaps inured to the pleadings and lobbying of trade associations, but we do need to ask where the line lies between valid motivated belief and wilful misrepresentation. In any circumstance, it seems to me that these latest emanations are shrouded in the rank odour of advanced decomposition, tinged, perhaps, with elements of fear.

Con Keating is head of research at Brighton Rock Group