February 23, 2004
Jonathan G. Katz, Secretary
RE: Concept Release: Request for Comments on Measures to Improve
Dear Mr. Katz:
This letter is submitted on behalf of Goldman Sachs Asset Management, L.P. in connection with a request by the Commission for comments on issues related to the disclosure of mutual fund transaction costs. The issues on which the Commission seeks comments were published in Release Nos. 33-8349; 34-48952; IC-26313 (Dec. 18, 2003) (the "Release").
The Commission requests comment on whether mutual funds should be required to quantify and disclose to investors the amount of transaction costs they incur. We assume and support additional quantification and disclosure of transaction costs to mutual fund shareholders and welcome the opportunity to try to make these disclosures the most meaningful possible.
Based on this assumption, we first submit several general comments for the Commission's consideration regarding the disclosure of mutual fund transaction costs. We then submit responses to the specific questions raised in the Release.
A. General Comments
(1) We believe that all mutual fund transaction costs are reflected in a fund's total return and that, in general, total return information is the most meaningful information to investors. However, we also believe that further transparency and clarity of expenses borne by shareholders (to the extent that such information can be valuable to an investor seeking to invest in a mutual fund without additional burdensome costs) is a necessary and important public policy and mutual fund industry goal.
(2) To frame our comments on transaction cost measurement we would like to differentiate between explicit and implicit costs. Explicit costs are commissions, fees and taxes charged on individual trades as an addition to or deduction from the gross consideration to calculate the net consideration. Explicit Commissions are already subject to reporting requirements. Implicit commissions may also be added to the security price as a mark up or mark down, and are included in the gross consideration prior to any addition or deduction of explicit commission. Other Implicit transaction costs, including spread costs, market impact costs, and opportunity costs, are difficult to measure and involve some degree of subjective determination.
(3) The measurement of transaction costs is a complex subject with no current industry standard. Explicit commission cost measurement is reasonably advanced for agency transactions in equities (on exchanges and NASDAQ) and for futures contracts. These types of transactions are fully transparent with explicit commissions. For fixed income and over-the-counter securities, measurement is less developed and transactions do not generally have an explicit commission cost.
(4) We believe that to the extent that future transaction cost information is required, disclosure of brokerage commissions should be presented as a percent of assets (including explicit and implicit costs), and have a preference for the implementation shortfall method of calculation of total transactions costs. Further, we believe such information should be in combination with more prominent disclosure of portfolio turnover measures.
(5) The quality of output from the measurement of implicit transaction costs is dependent on the quality of data retained by investment managers' order management systems. It is doubtful that all investment management firms have the technology to automatically capture the data required, which could be subject to differential interpretation and capture given the different market mechanisms.
(6) We believe that in general: (a) disclosure of transaction costs in terms of a percentage of a fund's assets provides the most meaningful information and a better basis for fund-to-fund comparisons than disclosure of the dollar amount of transaction costs; and (b) estimations and subjective determinations should be avoided in disclosures that are provided to investors.
(7) Measurement and disclosure of transactions costs is only meaningful if such information can be shown to be accurate. In the case of fixed income securities, the actual transactions costs associated with buying and selling securities is known only to the dealer. These costs are not known and are never disclosed to the party who actually initiated the transaction. It seems inappropriate to ask a fund to disclose this information because such information could be incorrect, misused or misunderstood.
B. Responses to Specific Questions in the Release
(Note: The numbers below correspond to the numbers in the Release.)
1. We note that given the lack of clear and consistent standards for determining transaction costs, investors are not likely to get information which can be compared from one fund to another. However, net fund performance which includes the effect of both fund expenses and implicit and explicit trading costs levels the playing field and provides the most comparable basis for an investor to compare and analyze a fund investment.
2. If the Commission determines to require quantification of all transaction costs, then we believe disclosure of brokerage implicit and explicit commissions paid as a percent of assets and average commission per share paid could be disclosed in the Financial Highlights table in the prospectus.
Among the options described in the release, we believe the best measure of transaction costs is the implementation shortfall measure, which measures the change between the market at the time the decision to trade is made and the actual price at which the trade is executed. For purposes of comparison among funds this absolute cost can then be compared to a benchmark. We note, however, that even this measure has shortcomings. For example, the decision price is the point at which the measurement starts, for which there will be different interpretations many of which will depend on the manager's investment process and ability to capture data at a number of points in that process; some managers may not have the required technology to achieve this data capture. Further a benchmark would need to be defined for each fund, which will require determination by the Commission. This would be especially challenging with fixed income securities where it may not be possible to capture accurate price data for all of the reference points in the process. The need for clear guidance from the Commission that results in uniform, objectively-determined data is necessary and important to the effective dissemination of comparable data that will not result in investor confusion and potential manipulation of the types of transaction costs actually incurred by investment advisers.
We think that the "trade effect" alternative measure described in the Release should not be used, in part because this measure is biased towards a "buy and hold" strategy as contrasted to an "active trading" strategy. This bias is not supported by proof that one strategy is better than another.
We think there is potential for the "sell-side" alternative measure described in the Release. However under the implementation shortfall measure it takes one part of the process out of the assessment of transaction costs - the price move for the period between the decision point and the order being sent to market. We also think it will be very complex to collate the information from all the different brokers, and to track the part of the trade for the mutual fund if an order is executed across more than one account at the same time.
3. We believe that quantification (expressed as a percentage) and disclosure of brokerage commissions, but not other implicit transaction costs, would provide useful information to investors and should be located in the Financial Highlights table. However, we believe that these should include implicit brokerage commissions. For example, in the event of a principal execution the mark up or mark down should be disclosed as well. Not including implicit commissions subjects the metric to be "gamed" as one could execute all transactions with reduced or no explicit commissions.
4. In our more recent experience, close to 100% of NASDAQ trades are subject to commission or commission-equivalent fees and does make quantification of these costs possible. However, please see question number 3 for potential issues.
5. We believe that information on brokerage commissions (i.e., both implicit and explicit commission costs), in combination with turnover measures, is not misleading and gives investors meaningful information. We believe that quantification of other transaction costs (including spread costs, market impact costs, and opportunity costs) are (a) more difficult to compute, (b) more imprecise, (c) liable to subjective, non-uniform determinations, and (d) subject to greater potential for misinterpretation by investors. In addition, as stated previously, we believe these costs are already reflected in a fund's total return information.
6. We believe that investors would gain little value from disclosure that details the portion of trades that are performed on a commission basis, or spread basis, or some other basis. This information would be difficult to understand, difficult to standardize and not provide information that an investor would effectively use to make an investment decision. We further note that sophisticated institutional investors (i.e., pension funds) do not request this information from us currently.
7. We believe that the publication of brokerage commission data may influence investment managers regarding the split between agency and principal trading. The use of soft dollars (including third party soft dollars) and the quantification of soft dollar benefits would in all likelihood have some impact on the use of soft dollar transactions. To some extent this disclosure is already provided to investors under current regulations.
8. In general, we do not favor disclosure requirements that involve estimates or subjective determinations because of, among other things, (a) the greater potential for misinterpretation by investors and (b) the decreased ability to make meaningful fund-to-fund comparisons.
9. For the reasons stated in the response to Question 8, we do not favor a requirement to measure and disclose the portion of the spread costs that represents payment for executing a trade separate from the portion of a spread that represents market impact costs.
10. For the reasons stated above, we see some practical concerns with a requirement either to: (a) quantify all transaction costs; or (b) quantify all transaction costs except opportunity costs. If this is required , however, we think the implementation shortfall measure compared to a benchmark will provide better disclosure than the alternative measures, as discussed in our response to question 2. However the choice of the same benchmark for comparison is essential for the investor to compare between funds. We do not foresee a consensus forming between managers of similar types of funds in choice of this benchmark.
11. We believe the "trade effect measure" as described in the Release (that is, a measure that includes all realized costs of trading plus any short-term trading profits or losses incurred as a result of the timing of the trade) will require large technology expenditures for mutual funds and their service providers with almost no benefit to investors.
12. We believe that if the Commission requires disclosure of only one transaction cost measure, that measure should be the implementation shortfall measure.
13./14. We do not believe commissions paid should be reflected as an expense in fund financial statements. Commission costs are the equivalent of acquisition or disposition costs and should be reflected in the cost basis of securities purchased or sold. While we believe that commissions reduce fund returns and therefore "look" like an expense, comparable comparisons would be very difficult given explicit vs. implicit commission structures. This is in accordance with generally accepted accounting principles for the investment company industry (as defined by the Audit Guide) as well as accounting principles for other industries.
15. The Commission has asked whether mutual funds and their managers are better able to track the portion of commission costs that purchase research services from brokers. We believe that, especially with brokers that provide in-house research, any split between execution and research applied to commissions will be subjective because these services are not commonly quoted separately. Finally, since many managers manage both mutual funds and separate accounts, it would be difficult to determine how the research itself is allocated between the two.
16. The categorization of funds into different categories would not seem a reasonable structure even if guidance was given to provide some standards for allocation of each fund to a category. This would inevitably be a very subjective judgment resulting in the potential for increased real shareholder confusion and variability in self-assessment.
17. As discussed previously, we believe that the current disclosure requirements relating to transaction costs do provide investors with significant information. We believe, however, that this disclosure could be improved as discussed in the response to Question 19.
18. While portfolio turnover rate is not a perfect proxy for fund trading costs, it is generally viewed as being highly correlated with transaction costs. It can be easily calculated by funds, easily understood by investors and readily comparable among funds. We think that greater prominence of this information in the prospectus would be appropriate along with information for longer time periods (i.e., 10 years). This could be in a new "special" chart along with a detailed plain-English description of what the data generally means to actual shareholder expenses of investing in a pooled fund structure. However, the costs associated from trading vary greatly from manager to manager even though they may have the same turnover and thus the metric is inherently subject to being potentially misleading if the goal of the disclosure is to provide transparency and comparability of transaction costs.
19. We believe that the existing disclosure requirements regarding the payment of brokerage commissions (i.e., both implicit and explicit) can be improved by requiring the disclosure of commission payments (explicit and commission equivalent) as a percentage of a fund's total assets.
20. Although we recognize that flows are an important component of portfolio management and may have an effect on transaction costs, we do not believe that average daily net flow information would add information from which an average investor could make a carefully considered investment decision. It would require too much explanation and could not be simplified in a way that would foster comparisons among funds. In addition, flows may or may not be equitized, and thus even the same flow in two different funds may have different implications.
21. As an investment manager to large institutions as well as mutual funds, we believe that a transaction expense could be beneficial on two fronts: i) to reflect the cost to invest/disinvest to handle liquidity needs of shareholder and (ii) to help reduce the costs/effects of short-term trading. In particular, an investor who invests in a fund can get equity exposure without bearing the full cost of the expenses associated with investment (i.e., those expenses are borne by the fund and passed on indirectly to all shareholders). If that shareholder instead purchased the equities directly, they would bear these expenses. This therefore could result in long-term shareholders bearing transaction costs over time for all investors (both purchasers and redeemers), while the active traders would not be "paying" for that liquidity.
A transaction expense would also help reduce the benefits of market timing to active traders by reducing potential short-term profits by the entry/exit fee. Further, since this fee would be payable to the fund, the shareholders, rather than the Fund's service providers, would receive all the benefits.
22. We believe that average commission rates for agency trades (and other commission equivalent costs) could be disclosed, but not implicit transactions costs given the complexity, lack of standardization and potential confusion to shareholders. We also believe that this metric can be gamed as investment managers could have the executing brokers book all transactions with implicit commissions and thus have an average commission rate of zero.
23. We believe that total return (i.e., net of all fees and transaction costs) levels the playing field for all funds and is the best measure for an investor to assess fund returns. Since investors could never receive the gross returns such information would or could be potentially misleading and add confusion to the investor fund assessment process.
24. See #23.
25. Gross returns should not be presented. See Question 23.
26. See #23.
27. See #23.
28. See #23.
29. See #23.
30. We believe that certain information currently requested by institutional clients (i.e., Plexus or other execution effectiveness reports) could be provided to the board to help evaluate best execution obligations. A review of the results interpreted by the Board could then be provided to the fund holders.
31. Yes. Boards and shareholders should receive information to assess soft dollar and directed brokerage usage/payments.
32. One problem in evaluating execution cost measurements is in identifying a standard of comparison. It may be difficult for fund directors to assess the fund's execution performance statistics in a vacuum, without comparison with other funds' statistics. Further, we do not believe that the SEC should establish standards that do not provide flexibility for the investment adviser to exercise their experienced judgment in obtaining best execution.
33. Given the complications of separating commissions into the different components, as discussed above, fund advisers should not be required to provide fund boards with a detailed internal allocation of their uses of brokerage commissions. However, we believe a robust discussion and reporting of commissions, soft dollar benefits (if any), execution services and other services (i.e., conference calls, seminars, company meetings with management, etc.) with the Fund's board is an imperative.
We thank you for this opportunity to submit our comments on these issues. Questions regarding this letter may be directed to Caroline Taylor at 44 207 774 8388 or Howard Surloff at 212-902-3309.
Very truly yours, Caroline Taylor