16 August 2018, 4:06pm
Feared and loathed in equal measure, like all truly scary things, its name is suitably short; ‘the KID’. After lots of to-ing and fro-ing between the EU Commission and the European Parliament (who rejected the initial draft KIDs legislation bill by an unequivocal 602 to 4), the KID arrived. Since its arrival, Enterprise Investment Scheme (EIS) and Venture Capital Trust (VCT) managers have had to change the way they disclose their fees to investors.
The new rules came into force on 3rd January this year and require fund managers to use a standard “Key Information Document”, or KID. The KID is a standardised document that should be no longer than three pages, contain no jargon and answer the following questions for investors:
What is the aim of the KID?
While the aim of the KID is to help investors to better understand and compare the key features, risk, rewards, and costs of different PRIIPs (packaged retail investment and insurance products) , they can be difficult for customers to understand. The methodology for calculating transaction costs to be included in KIDs has caused issues in accuracy and transparency, including some resulting in negative figures.
The new rules impact nearly all retail funds. However the government-approved tax efficient schemes (EIS and VCTs) in particular hold a high risk of investors misinterpreting fees. We will now no doubt see many investors making product selection decisions based on a three page summary of the risks, costs, performance and so on, without reading the full Information Memorandum or listing Prospectus. Given the volume of marketing material from most providers, this isn’t surprising.
Looking out for hidden fees & ‘icebergs’
Take fees, the disclosed charge in the KID could be only the visible tip of the ‘charging iceberg’ lurking underneath. As in the mainstream market, there are two sorts of charges; those that are known in advance (the disclosed fees) and those that cannot be known in advance, such as trading, administration or other variables that grow the headline costs into the Total Expense Ratio (TER). Most VCT managers cap their TERs, but this is arguably as a result of the funds being listed PLCs and down to their reporting requirements.. EIS or SEIS Funds don’t have the same reporting requirements, as they are not listed
In addition, the majority of EIS and VCTs charge portfolio companies arrangement, monitoring and director fees. Whilst it can be argued that these are costs that are paid by the shareholders of the investee companies, given the fund is a shareholder, the investors in that fund are effectively paying at least a portion of these fees in addition to the other fees above. Disclosure of these fees already lacks transparency and almost certainly will not be included in the KID under the current format, nor capped. Normally in the small print there will be the words “the manager reserves the right to charge market deal and monitoring fees”.
Comparing different KIDs
This lack of transparency could be misleading especially given the proposed KID is meant to be a comparison tool. For instance, Parkwalk Opportunities EIS Fund costs include the initial, dealing, management, admin and performance fees as a percentage of the net subscriptions into the Fund in their KID, as they aim to be as transparent as possible to their investors. Another growth EIS fund in the market does not include these percentages in the KID, and only show the percentage impact that the different types of costs have on what the investors get back. This can result in certain fees being omitted altogether from what is presented in the KID.
While the fees in this market are completely justified, there is no justifiable reason why managers can’t be transparent about all the charges. Of course, if the costs borne by investors were more transparent, market forces would undoubtedly drive them lower.
Looking ahead – is there a life raft?
The new European legislation is significantly increasing the disclosure requirements on fund managers, but as with all regulation it can be a double edged sword. If investors/advisers have greater confidence they are seeing all fees but the regulation fails to provide that, then we’ll be in a worse position than we are currently.
We will see what the final rules are but the one thing worse than not having a life raft onboard is having one that turns out to be completely useless when you decide the time has come to rely on it.
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