Background

We want to investigate ways of understanding the market impact of measures used to disclose the price of retail investment products.

An interesting case study is the two price measures currently required for retail investment products in the UK which provide a single figure to indicate the level of expenses and charges (these measures are not both required in all circumstances, while other presentations of price information are also required). These are the Reduction in Yield (RIY) measure and the Total Expense Ratio (TER). They are defined as follows:

  1. RIY – the difference between a hypothetical annualised investment return on the assets underlying the product and the same return after taking account of expenses and charges.
  2. TER – ongoing expenses and charges expressed as a percentage of the value of the fund.

One significant difference between the RIY and the TER is the level of price transparency they support. This is because the TER does not take into account entry and exit charges and so does not convey the full cost of investing on its own; entry and exit charges, if they apply, are disclosed separately. In contrast, the RIY uses a projection at a hypothetical rate of return using a standardised investment return specified by the regulator to provide a single figure which includes the impact of all entry and exit charges.

A key hypothesis would be that the market impacts associated with measures such as RIY or TER might therefore be a function of the transparency they lend to charges and the impact this has on competition between providers.

Objective

The objectives of the research project are to:

  • investigate models for the effect of transparency of charges on consumer surplus and charges, and the conditions under which lack of transparency generates a market failure;
  • model the advisers’ role and investigate the effect of transparency of charges on advised sales, taking account of the effect of providers’ commissions offered by product providers; and
  • investigate the interaction between different pricing measures where information drawing on multiple measures is provided to a consumer.

Method

This research applies the economic technique of 'game theory' to model the effect of reduced transparency of charges on consumer surplus. The model takes account of the following:

  • varied levels of consumer sophistication;
  • advisers’ recommendations on consumer choices;
  • adviser behaviour, e.g. whether to recommend the product with lowest charges for the customer, or maximise the adviser’s own profits; and
  • the impact of the regulatory monitoring of adviser behaviour and the effect of regulatory penalties.

The project is not empirical and so will not provide a quantification of the benefits of rules on transparency of charges. However, the output of this project can be used to better understand:

  1. the gain in consumer surplus, for instance by applying data to the model; or
  2. in the absence of data, the gain in consumer surplus under different hypothetical scenarios.