Most managed funds have a buy sell spread cost. But what is it, and how does it get calculated? We have the answers.
What is a buy sell spread?
Buy sell spread costs of managed funds are extra costs that an investor pays when they either invest in or withdraw from a fund. Buy sell spreads are usually expressed as a percentage of the unit price (e.g. 0.25%).
The purpose of the buy and sell spreads is to ensure that investors entering or leaving a fund bear the costs of buying and selling fund assets as a result of their transaction. If you invest $100,000 into a fund, the manager of the fund will need to invest that money and that will incur transaction costs. Transaction costs include such things as brokerage, bid-ask spreads, settlement and clearing costs and buy sell spreads on unlisted investments. Likewise, if you withdraw from a fund, the manager must sell some of the fund assets to provide the cash to make your withdrawal payment. Again, this will result in transaction costs being incurred.
The buy sell spread cost is related to the goal of treating all investors in a fund equally. If no buy sell spread were charged, existing investors in the fund would have to bear the costs of investors who enter or leave, which would be unfair.
Calculating buy sell spread costs
All funds calculate a unit price, which is a measure of the value of a unit. The unit price is calculated for a fund by dividing the net asset value of the fund by the total number of units held by investors in that fund. When the fund issues new units to an investor, a buy spread is added to the unit price. When an investor leaves a fund, a sell spread is deducted from the unit price. Unit prices are usually calculated to 4 decimal places. Let’s say the unit price for a fund was $1.10, the buy spread was 0.25% and the sell spread was 0.20%. The unit price for issuing units including the buy spread would be $1.1022 ($1.10 + $1.10 * 0.20%). The unit price for withdrawing from the fund including the sell spread would be $1.0978 ($1.10 – $1.10 * 0.20%).
Buy sell spreads can vary depending on many factors and can change over time for the same fund. Three of the largest impacts on buy sell spread costs are the type of assets the fund holds, the investment strategy and the size of the fund. Buy sell spreads tend to be lower where funds are larger and hold highly liquid assets. Conversely, funds that hold less liquid assets such as small caps, or more exotic assets which are less frequently traded, can have much higher buy sell spreads. Usually, buy sell spreads range from around 0.05% to 0.50% of the amount invested or withdrawn from a fund.
When you pay a buy sell spread
You are likely to pay a buy spread whenever you make an investment in a fund and a sell spread when you make a withdrawal from a fund. Some funds have more than one investment option and you may also pay a buy sell spread if you change investment options within that fund.
There are some exceptions. For example, when distributions are reinvested into more units, a buy spread is not usually payable. This is because no money enters or leaves the fund, so no assets are required to be bought or sold.
If you are a long term holder of a fund, then a buy sell spread will make less difference to your overall returns. But for an investor entering and exiting funds over a short period, the spread between the buying and selling price can be an important cost.
Listed funds such as ETFs and mFunds, where the price is based on the unit value will have a buy sell spread. But listed funds where the price is set by the market (such as REITs and LICs), generally do not have a buy sell spread. This is because in this case you are buying existing units from another investor, rather than the fund issuing or redeeming your units. Because this type of transaction doesn’t require the fund to issue units, there are no costs to the fund.
Buy sell spreads can change
As the buy and sell spreads are an estimate of transaction costs, they are subject to change from time to time. The manager or responsible entity of a fund sets the buy sell spread and will usually review it at least annually. We recently reviewed the buy sell spreads for our Affluence Investment Fund and reduced them from 0.35% to 0.25% as a result of growth in the fund size and lower transaction costs.
The buy sell spread amounts can be found in the Product Disclosure Statement for a fund and usually also in the fund reports or website page.
A buy sell spread example
If you invest $100,000 into a fund with a buy spread of 0.25%, you will pay an immediate cost of $250 ($100,000 * 0.25%) and thus on day one your investment would be worth $99,750. If you then sold that investment again one day later (assuming the unit price didn’t change in the meantime), you would pay another $249 ($99,750 * 0.25%), and your exit amount would be $99,501.
Comparisons with other investments
A buy sell spread for a fund can be compared to transaction costs for other investments such as property or listed shares.
Buying property will incur stamp duty, legal fees and other up front costs. Selling property will likely involve agents fees and legal costs. These may be a substantial as a percentage of the property value.
When you buy listed shares, you will incur transaction costs such as brokerage and a bid ask spread. Brokerage typically ranges from 0.10% to 0.30% of the value of the shares you transact on but can be more for very small parcels. The bid ask spread is the difference between the best buy offer and the best sell offer at any given time. This amount may be very small for a large stock where shares are traded frequently and in high numbers. But for smaller, illiquid stocks it can be 1% or more.
Buy sell spreads are something to be aware of. You can compare them between funds and perhaps between other investment types. But they are just one of the many factors you might consider when looking at managed funds. Our guide to managed funds explains in more detail how managed funds work and what we look for.
Take care and all the best with your investing.
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