45 Fremont Street, San Francisco, CA 94105
BARCLAYS GLOBAL INVESTORS
February 27, 2004
Jonathan G. Katz
Re: Concept Release: Request for Comments on Measures to Improve Disclosure of Mutual Fund Transaction Costs (File No. S7-29-03)
Dear Mr. Katz:
I am writing on behalf of Barclays Global Investors, N.A. and Barclays Global Fund Advisors (together, "BGI") in response to the recent Concept Release by the Securities and Exchange Commission (the "Commission") and the Commission's request for comment relating to the disclosure of mutual fund transaction costs. We support the Commission's efforts to increase investor awareness and appreciate the opportunity to comment on these important issues.
BGI is one of the world's largest institutional investment managers and is the world's largest provider of structured investment strategies such as indexing, tactical asset allocation, and quantitative active strategies. As of December 31, 2003, BGI and its affiliates managed over $1 trillion dollars in assets globally, including $217 billion in active strategies and over $105 billion in mutual funds and exchange-traded funds. BGI is a subsidiary of Barclays Bank PLC.
BGI is committed to delivering best execution in the trading activity we undertake on behalf of our clients. We support initiatives designed to promote competitive and open market structures that reflect best practices and maximize the opportunity for best execution of market participants' orders. Recent events have focused attention on practices within the mutual fund industry and we believe the Concept Release is well timed in this regard. Because excessive portfolio transaction costs can have a substantial negative impact on performance, we believe it is important for mutual fund investors to have an understanding of both the impact of such costs and the potential conflicts of interest relating to portfolio execution. With this in mind, we support requiring funds to provide more complete information on trading costs and "best execution" and to disclose potential conflicts relating to portfolio transactions, such as soft dollar and directed brokerage arrangements. However, as relates to the specific proposals in the Concept Release, we have several recommendations and concerns. These recommendations and concerns are discussed below.
II. Soft Dollars and Directed Brokerage.
The Concept Release notes that fund managers may be subject to conflicts of interest when executing portfolio transactions, such as when commissions are used to pay for research and other services (soft dollars) or distribution (directed brokerage). The Release requests comment on whether investors should be provided with mandated information on soft dollars and directed brokerage payments.
BGI believes it is important to distinguish between proposals relating to the use of fund assets to help pay the expenses of a fund or its adviser (i.e., soft dollars and directed brokerage) and those relating to the disclosure of explicit and implicit transaction costs. From the viewpoint of an individual investor, both expenses and portfolio transaction costs reduce realized investment returns. However, from a regulatory perspective, we believe it is important to differentiate between these factors because the use of soft dollars and directed brokerage raises potential conflicts of interest that directly affect a fund's ability to obtain best execution. BGI does not engage in soft dollar transactions because we feel that this practice presents potential conflicts of interest and detracts focus from one of the core responsibilities of an investment manager: obtaining efficient, low-cost portfolio execution. Because of these potential conflicts, BGI believes it would be appropriate for the Commission, at a minimum, to require funds that participate in soft dollar or directed brokerage arrangements to provide clear narrative disclosure of such policies and arrangements. In addition, since the cost of such soft dollar and directed brokerage transactions should be readily quantifiable, we suggest requiring disclosure of the commission amount of any soft dollar and directed brokerage transactions. In order to be most useful to investors, we suggest requiring such disclosure in fund prospectuses and also in any sales literature that discloses performance information. A possible approach would be to require the commission cost of soft dollars and directed brokerage to be quantified and expressed as a percentage of a fund's average daily net assets in a way that would facilitate comparison to a fund's investment performance and also comparison between similar funds. A high percentage could suggest that soft dollars and directed brokerage are being used inefficiently. This would help investors evaluate both the extent of potential conflicts and the impact of soft dollars and directed brokerage transactions on fund performance.1
III. Disclosure of Portfolio Transaction Costs.
The Concept Release asks whether investor decision-making is harmed because investors lack numerical information about fund transaction costs. We are concerned that the difficulties in quantifying and disclosing implicit transaction costs will cause quantitative disclosure of fund transaction costs to be too technical to be of use to most investors, or, if implicit costs are excluded, too simplistic to be of practical value. Mutual fund investors currently receive disclosure of both pre- and post-tax performance information in a format that facilitates comparisons between similar funds and asset classes. Since portfolio transaction costs, and their impact on performance and tax-efficiency, are already "built into" the standardized performance information currently available to investors, we do not believe that specific quantitative disclosure of portfolio transaction costs will add incremental value to the decision-making process of most investors.
The Commission has sought comment on whether quantification of brokerage commissions paid in the prospectus fee table or elsewhere would be useful to investors. We suggest that although this approach provides incremental information to investors, it does not add any incremental value to an investor's decision-making process. This approach focuses only on those costs that are easiest to quantify (i.e., brokerage commissions) while ignoring implicit costs (such as spreads on principal transactions, market impact costs and opportunity costs) that are harder to measure but may have a more significant impact on fund performance than actual brokerage commissions paid. Any proposal that does not account for implicit costs would be incomplete and of marginal value since it would not present a full picture of a fund's transaction costs and efficiency. To the extent such disclosure ignored implicit costs it could be potentially misleading.2
A possible alternative to quantifying only brokerage commissions paid would be to quantify implicit transaction costs as well. The Concept Release discusses several possible alternative approaches to quantifying implicit costs. However, these alternatives are complex, subjective and difficult to standardize. Currently, there are no commonly accepted methodologies for computing impact and opportunity costs or for adjusting these costs to reflect market movements.3 Although institutions often use one or more of these approaches to quantify and assess the efficiency of their own portfolio execution process, each of these approaches relies on methodology or assumptions that are quite complex and may not reflect the views of other market participants, thus making useful comparisons difficult.4 In the absence of a standardized approach to analyzing and evaluating implicit trading costs, it will be difficult to standardize methodology and disclosure. To the extent any disclosure about trading costs is not based on standardized methodology and assumptions it will not be readily comparable between funds and will be of little or no utility to investors.
Additionally, we believe the costs of analyzing and reporting implicit trading costs would be significant for investors. In keeping with our fiduciary and best execution obligations, BGI computes transaction costs on a global basis and expends considerable resources in measuring, analyzing, and ultimately controlling these costs. We do this because it is clear that they directly impact the return we ultimately can deliver to our clients. However, the incremental costs of any new requirements for compiling, auditing, and reporting of implicit transaction costs would likely be significant. To the extent such costs are paid out of fund assets, they will have a negative impact on fund performance. Given that we believe this information will not add incremental value to most investor's decision making process, we urge the Commission to carefully consider the costs of the proposals discussed in the Concept Release.
Finally, the Concept Release seeks comment on whether disclosure by markets or broker-dealers of their execution quality for institutional orders would be helpful to funds in evaluating execution costs. While the statistics proposed may be of interest to some, their applicability is likely to be limited because of the level of detail about, for example, prevailing market conditions, order size and security that would need to be quantified in order for such information to have practical application.
Because excessive portfolio transaction costs can have a substantial negative impact on performance, we believe it is important for mutual fund investors to have an understanding of the impact of portfolio transaction costs and potential conflicts of interest relating to portfolio execution. We support requiring funds to provide additional disclosure of soft dollar and directed brokerage arrangements because such arrangements raise potential conflicts of interest that could impact a fund's ability to obtain best execution. For the reasons discussed above, we do not believe investors would benefit from attempts to quantify and disclose explicit and implicit portfolio transaction costs.
We appreciate the opportunity to comment on the Concept Release and look forward to continuing to work with the Commission on these important issues.