Watch out for the buy/sell spread on funds

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The management fee on a managed fund is often the focus of analysis especially in the context of low-cost investing. But, for an investor entering and exiting funds, especially in a short period of time, the spread between the buying and selling price is equally important but often ignored.

There may be significant differences between the buy and sell prices, and the impact on performance is more notable in a low return environment. The costs of transacting in the fund are taken into account when the buying and selling prices are calculated and investors wear the cost.

Calculation of spreads

All investing comes with a cost, as both on-market and off-market transactions have different buying and selling prices, including direct share investing. In the case of funds, the difference between the buying and selling price is called the spread, often expressed as a percentage of the fund’s net asset value (NAV). The manager of a managed fund covers the costs of trading and other transaction costs such as government taxes, brokerage and bank fees by setting different prices for entering or exiting the fund.

A fund may set the buy or sell prices at 0.25% either side of the NAV. This gives a 0.5% price spread, a material impact if an investor enters and exits a fund in a short period.

The price spread ensures investors are treated equally so that new investors joining the fund or those existing investors leaving the fund contribute towards the transaction costs. Investors that stay invested are not subjected to the financial cost of other investors’ transactions. In fact, investors staying in a fund long term usually benefit from people coming and going, because applications and redemptions in the same period may net out but the buy/sell spread is still paid and goes into the fund.

The spreads can change without notice due to changes in transaction costs, which can include the impact of adverse market conditions or improving market conditions. Vanguard changed its spreads in 2013, with the following reason: “…reductions to buy and sell spreads across 21 wholesale and retail fund offerings reflecting changing conditions in various markets, greater liquidity in the domestic bond market, reduced volatility in global fixed income markets and improved efficiencies in trade execution”.

Common transactions in a fund that attract a spread

All transactions into and out of a fund attract one side of the spread, such as:


Source: REST Super Product Disclosure Statement
Initial contribution to fund attracting a spread


 Switching between investment options attracting spreads

Source: REST Super Product Disclosure Statement

Spreads can vary for the same asset class

According to the ASX’s mFunds website, of the 176 managed funds available, the buy/sell spread can range from 0% to 2.2%. The spread is wider for funds investing in Asian and Emerging Markets and Australian Small Caps, while Fixed Interest funds have lower spreads. Some funds may invest in the same market such as Australian Equity but the spreads can vary, in this case from 0.33% up to 1.72% with a weighted average spread of 0.55%. The differences are likely to be due to factors such as how actively the fund trades, the number of stocks held, and the benchmark (small caps usually have wider spreads).

While management fees are quoted in per annum terms, such that a 1.2% fee is 0.1% a month, the spread is paid on entry and exit. If a 0.5% spread in paid within say three months, that equates to 2% per annum. For investors switching over short periods, the spread may cost more than the management fee.

ETF spreads are usually tighter

Exchange Traded Funds (ETFs) generally have tighter spreads compared with unlisted managed funds. The buy/sell spreads for ETFs are not set by the product provider (such as Vanguard or BetaShares) or even by individual market makers that create them and quote them. The spreads depend on the competition between market makers: if spreads are too wide, the market maker will lose business to other market makers.

An example of the difference in spreads between ETFs and unlisted funds is the unlisted managed fund Vanguard Australian Share Index Fund (for retail investors). It has a buy/sell spread of 0.16%, while Vanguard Australian Share Index ETF (ASX: VAS) usually has a spread of around 0.06%. But spreads on ETFs are not static and can widen during the trading day. This can happen especially at the open and close of the market due to volatility as market participants (market makers or authorised participants) are more actively creating and redeeming the units on behalf of the ETF provider.

The size of ETF spreads may also be impacted by the liquidity of the underlying individual securities that make up the ETF. ETFs that invest predominantly in large caps will most likely have tighter spreads than ETFs that invest in small caps or more obscure illiquid securities. The spread difference can be dependent on the ease with which new units can be created or redeemed by market makers.

Check the buy/sell prices

Costs including management fees and transaction fees are a major factor in a fund’s net investment performance. Transaction costs directly impact investors up front by paying for the fund’s cost of transacting.

Of course, there are buying and selling costs such as brokerage involved in directly investing in shares, and it may be a similar cost if the buy/sell spread on a managed fund has been set realistically. Nobody avoids transaction costs as they are a cost of investing regardless of the manner of investment.

Beating the market is difficult, and outperforming over the longer term can be made harder by higher costs from wider spreads.

 

Rosemary Steinfort is a Research Coordinator at Cuffelinks.

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8 Responses to Watch out for the buy/sell spread on funds

  1. SMSF Trustee September 14, 2017 at 10:21 AM #

    Such spreads are also incurred when you invest directly. EG when you buy a share, apart from brokerage you also incur a spread in that you don’t usually get it at the lowest price offered by sellers of that share, but instead you pay the higher price.

    So this article should be used to compare managed funds, not to compare funds with direct ownership.

    • Rosemary Steinfort September 14, 2017 at 10:37 AM #

      Hi SMSF Trustee,

      Thanks for your comment but I did say that there is a difference between the buying and selling price for direct share investing. The idea of the article was to point out that managed funds have a spread too, which some investors may not be aware of, and the spread is for transaction costs, not going into the pocket of the manager.

      Rosemary

      • SMSF Trustee September 15, 2017 at 12:13 AM #

        Yes, Rosemary. I was seeking to elaborate on what you said. Sorry if I gave the impression that you hadn’t touched on the existence of transaction costs in direct investments.

        Property of course has massive transaction costs, like legal fees and stamp duty, that a lot of that sector’s advocates conveniently ignore. Only seem to get mentioned when the first home buyer market is under discussion.

  2. Amateur lawyer September 14, 2017 at 1:52 PM #

    One issue with buy/sell spreads for super funds is that they must reflect no more than actual costs incurred (SIS section 99C (1) – “the fee must be no more than it would be if it were charged on a cost recovery basis”). This is very tricky and impossible to do – take an example – if someone switches from Growth to Balanced, then few of the underlying assets need to be sold, as typically the SAAs for both investment options are similar. But if they switch from Growth to Cash, then virtually everything needs to be sold. Typically a fund will charge a sell spread IRRESPECTIVE of where the money is going, which in theory is inequitable and possibly not in line with the SIS requirement. But show me a fund that does charge a different sell spread depending on where the money is going – I have never come across one! Ditto re buy spreads, same issue.

    Does this mean all super funds are in breach of SIS 99C(1)? And what if the fund is a growing fund, and switches are funded from positive cash flow, how are the spreads calculated then? To my mind this all means that the only funds truly meeting this “no more than cost recovery” requirement are those that charge nil spreads – but that brings in other inequity issues!

    I’d be interested in others’ views on this.

  3. Peter Dobrijevic September 14, 2017 at 2:24 PM #

    One reason I prefer direct investments in large cap equities is that spread is often only a penny. Also, individual investors can almost always dump their entire holding in a stock in a heart beat without affecting the spread. Try that with some of the LICs, hybrids, ETF’s, etc.

  4. Daryl September 14, 2017 at 10:11 PM #

    Yes a buy / sell spread is a fee and very difficult to factor in when comparing super funds – and as the article points out you can be hit with this fee without really understanding the mechanism.

    Is it too simple to avoid super funds that have buy /sell spreads until such time as they are banned and we have a level playing field ?

    • SMSF Trustee September 15, 2017 at 12:11 AM #

      Daryl,

      As a user of managed funds I would NOT want them to stop having buy/sell spreads. Otherwise every time another investor comes in or redeems, the costs of those transactions fall to me rather than to them! Buy-sell spreads, provided they are a reflection of the actual transaction costs, are essential. They certainly shouldn’t be banned – that’s not going to help anyone.

  5. Gary Lucas September 15, 2017 at 7:58 AM #

    Thanks for the article Rosemary. This is an area that needs more attention. RG97 will go some way towards that, however, the extension relating to property, the lack of understanding by some managers and overseas managers not being supportive of the process means that the legislation will not fully achieve its aims.

    Recently I have asked a few managers why the buy/sell is at the level they apply. Long silences are usually followed by, that’s the way it’s always been.

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