You will be able to list costs that reduce your return without appearing in the headline expense ratio.
Arjun compared two funds with almost the same expense ratio and expected them to perform almost the same. Over three years one trailed the other by more than the difference in their fees, though they tracked similar markets. Something was costing one fund more than its expense ratio showed. Usually, something is.
The expense ratio is the best single cost figure you have, but it is not the whole bill. This lesson covers the costs that reduce your return without appearing in it, so you can find them and at least write them down.
As lesson 2.2, Yearly charges: management fee, expense ratio and trailer fee, explained, the expense ratio covers the cost of running the fund. It usually leaves out the cost of the fund's own trading: broker commissions, transaction taxes in some markets, and the gap between the prices at which the fund buys and sells. These costs come straight out of the fund's assets, so they lower the NAV like any other cost, but they are not added to the expense ratio.
A fund that trades a lot pays more of them. The best clue is the turnover ratio, which roughly measures what share of the portfolio was bought and sold in a year. A fund with low turnover holds most of its positions for years. A fund with high turnover may replace most of its holdings within a year, and pays trading costs on each change. Index funds tend to have low turnover because they only trade when the index changes or money flows in and out, while active funds range from low to very high.
You will not find the turnover ratio on most factsheets. Look in the annual or semi-annual report. If your fund reports a high turnover, treat its expense ratio as an understatement of what you pay.
Funds hold some cash, to meet investors who want to sell and to wait for opportunities. That cash earns less than the market in most years. When markets rise, the cash does not rise with them, so the fund's return falls short of what it would have been fully invested, a cost known as cash drag.
Here is an example with made-up figures. A fund keeps 5% of its money in cash, and the cash earns 3% a year. In a year when the shares it holds return 10%, the 5% in cash earns 7 percentage points less than it would have in shares. The drag on the whole fund is 5% of that gap, which is 0.35 percentage points. In a falling year the cash helps, so cash drag is a cost mostly in rising markets, which over long periods have been more common than falling ones.
No document lists cash drag as a cost. The factsheet usually shows how much the fund holds in cash, and you can watch whether that share stays small.
Some costs have nothing to do with the fund's own accounts, so they could never appear in its expense ratio.
The first is currency conversion. If you invest Singapore dollars into a share class priced in another currency, your bank, platform or robo-advisor converts the money at its own rate. The gap from the market rate is a cost you pay on the way in and again on the way out, as lesson 4.3, What a robo-advisor really costs, noted.
The second is withholding tax on dividends. Many countries tax dividends paid to foreign investors at source, and how much is lost depends on where the fund is domiciled and which tax treaties apply. The fund receives dividends after that tax, so its return is lower than the index it tracks, which may be calculated differently. Build and run an ETF portfolio covers this in its lesson 3.3, Domicile and withholding tax on dividends. Look up the current position for your fund in its own documents or on the website of the relevant tax authority.
The third is anything your channel charges you directly: platform fees, wrap fees, advisory fees. Lesson 3.2, Fund platforms: lower charges, more of the work on you, covered these. They come out of your account, not the fund, so the fund's expense ratio never shows them.
Some funds charge a performance fee on top of the management fee, usually a share of any return above a stated hurdle or benchmark. Because it depends on returns, it is not a fixed percentage, and many factsheets do not show it in the headline cost. The prospectus explains how it is worked out: the hurdle, the share taken, how often it is measured, and whether the fund must first make up past losses before charging again. If your fund has one, read that section closely, because the detail decides how much it can take in a good year.
For the fund she holds, Wei Ling went through each of these. Turnover, from the annual report: moderate. Cash, from the factsheet: about 3%, an example figure. Currency conversion: none, because she pays in Singapore dollars for a Singapore dollar class. Withholding tax: applies to dividends from the fund's holdings, amount not stated. Platform fee: none at her bank. Performance fee: none.
Most of those cannot be turned into a precise yearly percentage, and that is fine. The point is to know they exist and which ones apply to you. In the activity below you will find your fund's turnover and list the costs outside its expense ratio that apply to you.
For one fund you hold, find its turnover in the annual report and list any costs outside the expense ratio that apply to you.
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