Luxembourg funds may well be too expensive. Investment fund managers of Ucits funds in Luxembourg, home to about a third of all such funds in Europe, have been ordered to review, and if necessary correct, the way they calculate the costs and fees of their investment funds and report back to their national regulator before April 1 next year.
Luxembourg, as a leading investment funds hub in Europe, is the legal home to some 10.000 funds that are widely known as Ucits, which stands for Undertakings for the Collective Investment in Transferable Securities. The EU has nearly 30.000 of these Ucits funds, considered one of the most popular types of funds for European investors.
Following a deep compliance check involving all national financial supervisors in the EU, CSSF, Luxembourg’s financial regulator, said on Thursday that it has started discussions with “certain IFMs” and is asking them to correct the shortcomings that have been identified.
Ireland, France, Germany are cheaper
CSSF said it has asked all investment fund managers to conduct, by the end of the first quarter 2023, a comprehensive assessment “with regard to the compliance of their policy, approach and arrangements related to costs”. It said this also applies to Alternative Investment Funds, of which Luxembourg has approximately 4.000.
News of the CSSF initiative comes amid a wider discussion about the relatively high costs of some types of funds in Luxembourg. Research by Morningstar for example shows that Luxembourg is more expensive than Ireland, France and Germany when it comes to actively managed, open-ended bond funds.
“Costs play a crucial role in a fund’s future ability to outperform, and all the more so for fixed income funds where both risk and return are modest in absolute terms,” said Mara Dobrescu, Morningstar’s global asset class lead for fixed-income strategies, adding that a high cost “nibbles” a greater proportion of the expected return.
Expensive funds are bottom performers
“We see that almost mechanically, the most expensive funds in a given period tend to be amongst the bottom performers in the subsequent three and five years. That’s why it’s disappointing to see that costs remain high for active bond funds domiciled in Luxembourg.”
The competition from passive investments has become more fierce, Dobrescu noted. “Investors can now purchase bond ETFs with costs from 0.05% to 0.25% on average, depending on the type of underlying exposure. Most ETF providers have actually chosen Ireland as their domicile of choice rather than Luxembourg, due to a more favourable tax ecosystem. With the advent of cheap ETFs and index funds, one can hope that this will put pressure on active managers to lower their fees as well, to the benefit of the ultimate investor.”
CSSF’s actions follow the publication in May of the results of a common supervisory action held by the European Securities and Markets Authority, or Esma, reviewing costs and fees. Esma said the probe underlined the importance of supervision on making sure that investors are not charged with undue costs, considering their high impact on investors’ returns.
While the Esma probe “broadly” reported “a satisfactory level of compliance” with the legal framework, several national supervisors found that there was room for improvement and to develop a better structured pricing process, the EU authority said in May. Especially smaller fund managers were found to have “less formalised pricing processes” when compared to firms with larger assets under management.
‘Lack of strong pricing process structures’
“Small Ucits managers appeared not to have strong pricing process structures in place and over-rely on portfolio managers for the pricing of the fund,” Esma concluded.
The Esma report did not refer to any specific country nor does it name any national regulator. Luxembourg’s CSSF however, now has given feedback and announced its “comprehensive assessment” of costs and fees.
In its 17-page feedback report, CSSF noted that its guidance - as part of a supervisory briefing - on pricing includes a notion of “undue costs” as well as characteristics of a structured pricing process. In relation to this requirement, CSSF has found “several weaknesses regarding the pricing process”.
The regulator also found “a certain disparity on the degree of sophistication of the pricing process as well as its standardisation”. “Poor processes and inconsistent analysis” were detected in a few cases, said CSSF, also noting “a lack of review of the level of fees in light of the performance of the fund”.
CSSF did not name individual funds in its feedback report.
Ongoing charges for active open-ended bond funds:
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