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Unit trusts uncovered: The impact of trading costs on your fund

by , 27 June 2014

The one thing that worries many investors about actively managed unit trust funds is the costs involved. They are significant. And these costs eat into your potential return.

Have a glance at a fund's fact sheet and you might think all costs are included in the total expense ratio (TER), but you'd be wrong. TER doesn't include one-off costs, such as the fund's trading costs. And the more the fund manager makes changes, the higher these costs.

So what are the true costs of trading active funds? Let's take a closer look…

A fund’s trading costs

Have you thought about what’s included in the trading costs of your fund? It will consist of brokerage fees and taxes, Cris Sholto Heaton in Money Week explains.

But there are other factors to consider. Some measures take into account the spread between the bid and offer. Other measures try to factor in the price impact. This is the effect that carrying such a large order has on the market price of the share.

An in depth study done last year by Roger Edelson, Richard Evans and Gregory Kadlec looked at 1,758 equity funds in the US between 1995 and 2006.

From their study, they found that the average expense ratio for the funds came in at 1.19%. They also found that average annual trading costs were 1.44%!

Total trading costs accounted for a large chunk of the price impact on the funds.

Fund managers trading too much put in poorer performances

Of course, fund managers were trying to beat the market and that’s why they ran up such high trading costs. If they managed to achieve a good fund performance, then these extra fees would be worth it.

But this study highlighted that the funds with the highest trading expense had the worst performance. Despite spending more on trading costs, portfolio performance didn’t do as well.

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This study was for US funds. And in fact, the situation could be worse here with dealing commissions, wider spreads and the price impact being far more.

So there you have it, the impact of trading costs on your fund.

Unit trusts uncovered: The impact of trading costs on your fund
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