What are the total investment costs incurred by funds?
There are three main types of costs incurred by funds:
Management charges, which are payable to the fund manager. The fund manager analyses the market to determine which investments the fund should buy and sell, and markets the fund to investors to ensure it has sufficient assets to be economic to run. These are included whenever we refer to fund charges (eg. in our comparison tables).
Administration costs, which are things like regulatory fees payable to the FCA, audit fees payable to the auditors who check the accounts, and custodian fees paid to custodians who safeguard the fund's assets. Occasionally the fund manager will pay administration costs out of their own management charges, but usually they are paid for directly by the fund. These are included whenever we refer to fund charges (eg. in our comparison tables).
Trading costs, which cover the costs of buying and selling investments. For example, the fund has to pay a broker to place trades in the stock market and it may have to pay stamp duty tax on certain types of investments. These are not usually included in fund charges, but are sometimes passed on directly to protect the majority from the cost of trading by a minority.
The first two are combined in the "total expense ratio" (also known as the "ongoing charge") for a fund. This is the number we quote whenever we refer to fund charges, and is what we allow for when we calculate projected returns.
The trading costs are not usually included in the total expense ratio but are sometimes passed on directly. This is to protect the majority of investors from the costs of trading by a minority. Different funds pass the cost on in different ways - either via a "dilution levy" or a "bid/offer spread":
A dilution levy is an explicit allocation of the fund's costs to the new investments. For example, if a new investment of £10,000 created £20 of trading costs for the fund, this £20 could be passed on explicitly as a dilution levy.
A "bid/offer spread" means that new investments pay a higher price for units, which indirectly contributes to the fund's costs. For example, if a new investment of £10,000 created £20 of trading costs for the fund, the unit price might be 0.2% higher.