QD View: Investment company cost disclosures – job done(?)

The long campaign on cost disclosure

 
The past month has brought a flurry of activity over the cost disclosure rules under MiFID and their impact on investment trusts. Bill MacLeod, managing director at Gravis, and one of the key players in the team that has lobbied for the proper treatment of investment trust costs, is, he says, ‘all smiles’, but admits there is still work to be done – by Cherry Reynard

The history of the problem is long and winding. It starts in 2008-09, when the regulators sought to address the lack of regulatory boundaries around private equity and hedge funds. This ultimately led to the AIFMD and, as MacLeod says, “unfortunately, someone ticked a box to include investment companies. From that point, investment trusts were captured within the same boundaries as these funds.” It was always, he says, “somewhat inappropriate” and set investment trusts on a specific pathway that has been onerous and expensive for the sector.

Via MiFID and PRIIPs, it culminated in onerous rules around cost disclosure, saying that investment trusts had to state the management charges of the investment company as if they were a deduction from the value of the holding. This appeared to conflate closed ended funds with open-ended funds. However, in this respect there is a key difference between the two in that investors’ returns on open-ended funds are driven by changes in the equivalent of an NAV which is eroded by costs, whereas investors in closed-end funds earn returns based on changes in share prices, and those share prices already reflect investors’ expectations of returns after costs.

This was a particular problem for wholesale buyers such as wealth managers who needed to add the cost of investment trusts to their costs. The effect was a kind of double-counting, with the management costs of the trust reflected both in returns and again as a charge to the buyer. This brought questions from clients and put wealth managers that used investment trusts at a disadvantage versus, say, a passive solution, or even an MPS offering (which don’t tend to use investment trusts). All the nuance that investment trusts could bring to a portfolio was drowned out by the illusion of higher costs.

The rest is history – discounts widened out, particularly in the less liquid trusts such as infrastructure or private equity. It coincided with interest rate rises, which compounded the problem. It appeared to herald a near-existential crisis for some trusts.

A group formed to bring this problem of mis-reporting to the attention of regulators and policymakers. Its players included MacLeod, wealth manager Ben Conway of Hawksmoor and multi-asset manager James de Bunsen of Janus Henderson, plus the AIC. They found the support of Baronesses Bowles and Altmann, who used their position in the House of Lords to raise awareness of the issue. After a period when they were all ‘soloists’, they eventually came together to form a choir, says MacLeod.

Altmann explains her involvement: “I have always spoken out for the consumer interest and worked to ensure consumers are treated fairly. This was an issue where the consumer was being misinformed, contrary to the rules of being ‘clear, fair and not misleading”. She brought a private members bill, and the group engaged vigorously with the AIC, IA, PIMFA and the FCA.

By mid-2024, it was clear the message had got across. The FCA published a report in the summer, which mentioned the need to get the issue of cost disclosure resolved. Bill says “It showed the message had been received and there was a willingness to try and work together.”

Among all of this, there was consultation on the new Consumer Composite Investments (CCI) regime by HM Treasury (the post-Brexit replacement for PRIIPs and MiFID), which they published in late 2023. MacLeod helped to secure responses from 330 recipients from market participants.
 

Welcome news

 
Finally, the news arrived on the 19th September that the FCA would apply ‘forbearance’ for investment trusts if they choose not to put a cost figure in their KID. The AIC guided investment trusts to leave it blank. There was a suggestion that investment companies would stop producing a KID altogether, but under Consumer Duty, platforms need a KID in place to facilitate trading. Without a KID, investment trusts risk being ‘deplatforming’. Fidelity has deplatformed a number of investment trusts this year for not producing KIDs.

It remained a problem that the initial statement only exempted investment trusts, not other players in the supply chain. That was resolved on 30 September, when the FCA issued a statement saying all distributors were covered by the new rules.

The final piece of the puzzle was on 7 October, when the Government published draft legislation for a new statutory instrument called ‘The Packaged Retail and Insurance-based Investment Products (Retail Disclosure) (Amendment) Regulations 2024′. The draft bill seeks to exclude investment trusts from PRIIPS and MiFID regulation permanently.
 

Remaining issues

 
There are still questions over the form of disclosure – expenses need to be disclosed, even if charges do not. MacLeod says: “We all feel it’s very important not to just say ‘no’ all the time, but rather to say ‘no, but here is an alternative’.” He says the team has done a lot of work on an alternative disclosure format and has come up with a workable replacement should KIDs be cancelled forever.

Conway says: “We are suggesting a ‘statement of operating expenses’. abrdn has been fantastic with its draft point of sale disclosure. It has extracted all the information from the report and accounts and put it in a template form.” He says the resulting document could become an industry standard for disclosure, even establishing a potential template for the new CCI regime.

The government has said investment trusts will be in scope for the CCI regime once it comes into force. The investment trust industry is now waiting for the results of the revised consultation and there may be further negotiations around how investment trusts are treated in this as well. This is imminent and the CCI regime is due to take effect in the first half of 2025.
 

The platforms

 
The biggest remaining problem, however, is the attitude of the platforms. The initial excitement around the resolution has been tempered by a backlash from high profile platforms such as Hargreaves Lansdown, who have raised objections to investment trusts putting a zero cost in the KID. This has prompted some head-scratching from the investment trust industry, who worry that it reflects a persistent misunderstanding of investment trusts.

Baroness Bowles has made a representation to the regulator, pointing out that investment trusts are now at risk of being deplatformed if they avail themselves of the forbearance rules. She takes issue with examples cited by the platforms to justify their position: “(They) say that if the investment trust stayed at the same price, its value in a year’s time would be lower because of the management fee that the investment trust manager charges – this cannot be so as the market price is the investment trust share price which he has said stays the same and that is the value to the investor.”

She reiterates that it is against consumer duty to require misleading disclosure, create dysfunction in the relevant market through requiring misleading information, deplatform because accurate information is given and to deny consumer access on the basis of a flawed decision.
 

Who wins?

 
The platform problem moderates the otherwise considerable success of the campaign. Either way, the problem for wealth managers using investment trusts is temporarily resolved. Conway says it is has hit the illiquid assets hardest, including areas such as alternatives, listed private equity or infrastructure and these are the areas likely to benefit most from the resolution.

Nevertheless, there are still hurdles to overcome. The platform problem is still a work in progress. The shape of the CCI regime will also be an area of negotiation, though it is clear that regulators are designing the new environment with a better understanding of the unique nature of investment trusts.
 
Cherry Reynard
 
One bit of good news that I discussed in this morning’s weekly news show is that the Fidelity platform will allow investors to buy RIT Capital Partners once again. RIT was one of a number of trusts that were forced to produce misleading KIDs and then shunned because they looked too expensive. This is a tangible sign that things are moving in the right direction.

I want to thank all the members of the campaign – the two Baronesses (who I got to interview), Bill McLeod (who, amongst other things, has been fighting the selling pressure that the cost-disclosure mess put on GCP Infrastructure – hopefully that discount will close now), Ben Conway and James de Bunsen (who also graciously gave up their time to help draw up the shortlist for the awards), and many others.

I also want to address one common point of confusion. There is no agenda here to pretend to investors that investment companies do not have overheads. In fact, one of the things that the campaign has been calling for is more disclosure. abrdn has led the charge here, producing new ‘statements of operating expenses’ for its trusts – you can see an example of the one that it created for Murray Income here. I hope to see these adopted universally.
 
James Carthew
 
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