MiFID II: Q&A

Past performance to be updated within 35 business days of calendar year end.
General annual update requirement (usually carried out at the same time as the past performance update)

Transaction costs are the costs associated with buying and selling the underlying investments within a fund. These are made up of a number of different costs, some of which are explicit, for example broker commissions and transaction taxes paid on each purchase or sale of investments.

Explicit transaction costs have been disclosed in fund annual financial reports for the last number of years, showing the taxes and commissions paid by the fund both as a percentage of the average fund net asset value and as a percentage of the total transaction values.

In addition, the implicit costs are required to be included in the cost disclosure. This is sometimes referred to as the arrival cost, which is the difference between the price of the transaction and the mid market price immediately before the order for the transaction was made. 

Implicit costs can be positive or negative, and they can vary depending on the type of instrument. For example, large cap equities can often be traded almost instantly, whereas smaller cap equities can take longer to trade, which means that the price has more opportunity to change from the point the order is placed to the time it is executed. This movement could go in the fund’s favour, resulting in a negative cost. This difference in liquidity also impacts the bid-offer spread, with large cap equities having lower spreads than small cap equities. 

This arrival price methodology only became mandatory for PRIIPs from January 2018, and before this date a number of different approaches were taken to provide a historic estimate of implicit costs.

Finally, where a fund employs anti-dilution techniques, for example by swinging the price of the fund or by operating a dual price, then the adjustments resulting from these techniques can be offset against the total transaction costs of the fund/class.

Explicit costs are made up of commissions and transfer taxes. Commissions vary dependent on the type of market and the type of transaction. But in general larger cap securities should have lower commissions than smaller cap securities. Also bond transactions do not have any explicit commissions. Another point to note is that commissions historically used to include research costs, but from the start of 2018 onwards, this cost is being borne by Artemis. In terms of taxes, stamp duty in the UK has the most significant impact on our fund range, being 50bps on purchases, but a number of other markets have taxes, e.g. financial transaction taxes in France and Italy, and some emerging markets also have taxes.

Both implicit and explicit costs will increase as the portfolio turnover of a fund increases. As an active fund management house, the turnover on a number of our funds can be higher than other funds, in particular passive funds.

The industry standard portfolio turnover rate calculation methodology only includes the turnover of physical holdings: bonds and equities. As the industry has developed and the use of derivatives has increased, the portfolio turnover rate calculation has become less relevant. Therefore, for those funds which use derivatives, the portfolio turnover rate will not include all transactions and be quite misleading, and so the costs associated with these types of funds can often be higher than the portfolio turnover rate would suggest.

In addition, the costs of FX transactions are now included in transaction costs. These types of transactions typically do not have any explicit costs and the costs are included in the spread or all-in rate applied to the transaction. The impact of these costs will depend on the FX exposure and strategy of the fund. The FX transactions relating to hedged share classes are allocated to those particular share classes. The costs on these types of transactions are normally very small, but given the scale of the FX exposure on some of funds, these costs can become sizeable.

Anti-dilution measures: the transaction cost disclosure can include adjustments to take into account the impact of any anti-dilution measures, so for the dual priced funds, a daily adjustment is included based on the net dealing into and out of each particular fund. On the single-priced funds, when the price is swung, the dilution adjustments made are offset against the transaction costs.

Asset managers are permitted to use different methodologies for estimating transaction costs under MiFID II, either interpreting the MiFID II guidelines, or using the PRIIPS methodology. Whilst a number of asset managers have adopted the PRIIPS methodology, there are a number of different approaches in the market. The three main approaches used in the market are:

The PRIIPS methodology estimates transaction costs using the ‘slippage cost’ methodology. Using this method, transaction costs are calculated at an individual security/instrument level as the difference between the price at which a transaction is executed, and the price as it stood when the order to transact was transmitted to a third-party (the arrival price).

During the transitional period, other methods were proposed in order to capture historic transactions. These allowed for the start of business prices to be used as a proxy for the arrival price, or if they were not available, the close of business price from the previous day. This methodology however, when applied, leads to large variations in the arrival prices used in the calculations, which resulted in anomalies or spurious cost figures across the industry.

An alternative approach has been taken by a number of asset managers, using pre-defined spreads for each security/instrument type to calculate the implicit costs of each transaction. This approach is similar to the PRIIPS methodology, but adopts pre-defined spreads rather than using the difference between the arrival price and the execution price.

Artemis calculated the implicit costs using the transitional methodology, but when these calculations were completed, the results did not appear to be indicative of the expected transaction costs and that the figures could not be considered to be fair, clear and not misleading.

Artemis then used a pre-defined spreads approach based on the historic fund spreads to estimate the implicit costs on each type of transaction, e.g. equities, bonds, derivatives, and it has used a market vendor to calculate the implicit costs on FX transactions.

It has been widely reported in the industry press, that some asset managers have adopted the PRIIPS slippage methodology, which has led to the disclosure of negative transaction costs on a number of funds, whilst other funds have reported costs which appear to be excessively high. These anomalies are thought to be a result of unreliable historic arrival price data provided by data vendors. Accordingly, distributors face challenges when comparing the fund transaction costs of different asset managers. 

The methodology used by Artemis for the historic period is based on spreads, the fund transaction costs cannot be negative, and the cost on each individual transaction cannot be negative. Therefore it is likely that this methodology will result in the estimated historic costs appearing higher than funds which have used the PRIIPS methodology where the implicit costs on each individual transaction can be either positive or negative dependent on the random walk of the market.

The transaction cost figure includes an element of implicit cost (“slippage”) which is the difference between the mid-market price at the time the trade is sent to the market (“arrival price”) and the eventual execution price of the trade. It is possible for the slippage cost to be negative; for example when buying an asset the arrival price might be higher than the actual price paid.

Also the offset resulting from anti-dilution techniques could in theory be higher than the fund transaction costs, where for example there are large investor inflows or outflows relative to the size of the fund and the underlying portfolio turnover, resulting in zero or negative transaction costs.

These figures are subject to different regulations, which are not exactly aligned. The ongoing charge published on fund documentation, such as a factsheet, is calculated under the methodology set out in guidance for the UCITS directive. 

The ongoing charges figure in the EMT is different because under the MiFID II/PRIIPs methodology other charges are additionally included, such as financing costs (bank interest charges, derivative financing costs).