RIY

richallum

Can anyone post the formula for calculating a RIY. To keep it simple, let's go with £5,000 invested over 5 years with 1.2%pa charge.

Jamie_Barnes

@richallum , I believe it is along the lines of the following:

1. Project forward at the growth rate allowing for all charges (initial costs are divided by projection term).
2. Project forward at the same growth rate but this time not including any charges.
3. Reduce the growth rate in calculation 2 until step two equals step 1.
4. Reduction in yield = growth rate in step 1 – resultant growth rate in step 3.

RIY in your example would therefore be 1.25%, give or take for rounding.

richallum

Thanks @Jamie_Barnes That's how I'd do it although use Goal Seek. A few of us are having 'discussions' with a software provider about how they do it and I was trying to see if there's an actual formula rather than actually doing the calc step by step.

Jamie_Barnes

Yeah, goal seek for step 3 all the way!

arongunningham

I've broken down how FE Analytics do it in their new calc if that's who you're referring to - they seem to add growth annually and compound charges monthly.

richallum

@arongunningham That's spot on. Can you share how you've broken it down We're doing the same so it would be good to compare notes. Happy if you'd prefer DM in here or email richard@theparaplanners.com

Gustavo_Fring

Taking it a step further, for replacement biz, you can use these projections to generate a Critical Yield for the recommended plan and then the Additional Growth rate required.

Just goalseek the growth rate required at the replacement plan to ensure the end values for both the existing and replacement plans is the same. So you might end up with a Critical Yield of say, 6.331%, representing an additional growth rate required of 0.331%, assuming 6% was used as the original growth rate.

You’d probably need to set boundaries as to what level of additional growth you deem to be acceptable/achievable.

Jamie_Barnes

RE: how FE works out the growth and charges, I've attached a spreadsheet just showing year 1 on your example which is how I think they do it, but they probably have a far simpler formula rather than what i've done.

RE: formula for working out RIY, I think this is the formula to do step 2 through 4, so if you have a set formula for step 1, you could possibly tie it all together with this:

Growth rate- ([(final projected value (from step 1)/ starting value) ^1/number of years -1] * 100) = RIY

Would be interested to know what you think and whether you've done it differently.

DanAtkinsonUK

I've got a support ticket open with FE asking them to explain how it works in detail. I'll let you know what they say in due course. This all looks really helpful and is something i've been looking at this week due to the number of users we have vs FE licences.

arongunningham

@DanAtkinsonUK I asked the same, this was their reply:

The reduction in yield is calculated by calculating the value of the portfolio for the entered period without any charges and also with charges and then dividing the value of the portfolio without charges by the value of the portfolio with charges.

The value derived without Charges/Value derived including Charges = Reduction in Yield

For example, I have created a test portfolio with 100% weightage of the Invesco Perpetual - High Income fund with citicode:PE12 with an initial investment of £1000 over a period of 5 years.

Value derived without any charges for this period is £1276.28 and the value derived with charges is £1,214.01 after 5 years. The charge entered is 1% annual portfolio charge

Now the Reduction in yield would be (1276.28/1214.01) which is 1.05. Hope this answers your question. Please write back if you have any concerns.

...This was received yesterday and I haven't had time to double-check what I thought was happening behind the scenes.

@richallum I will get something together after lunch (i.e. removing any of the firm's identity) and post it here asap. I have noticed my numbers are always ever so slightly off, but I hope that's just down to rounding. BRB!

richallum

@arongunningham that's the answer they seem to give anyone asking.

arongunningham

@richallum yeah my first skim-read i felt that the formula I used to match their results was a bit more complicated (but that could've been because I was making a mountain out of a molehill)

EDIT: Anyway, I have attached the spreadsheet we use with the formulas/results which match FE Analytics, so we have some idea that we're on the right lines - FE won't be wrong, will they?! (you enter data on the first sheet and the results are on the second - we then copy the tables into our reports).

DanAtkinsonUK

Thanks @arongunningham that's an interesting spreadsheet. I'm not convinced by FE's methodology (or indeed their ability to explain it).

I don't think that annual fees should be deducted on day 1 (unless they are in real life). I would expect an ongoing adviser (etc) fee to be deducted from the end of month 1 (day 30/31) instead... Making progress modelling this in excel. Rounding is going to be an issue as it will (by default) calculate to fractions of a penny which also won't reflect real life.

I've put my comms with FE below in case this helps people understand what they are doing. I'd feel much more comfortable if they just documented it - they must know what paraplanners are like!!

I asked FE:
1. What is the difference between the Net Yield and the Reduction in Yield?
2. How is the Net Yield defined/calculated?
3. How is the Reduction in Yield defined/calculated?
4. Does the system pull the costs of the portfolio or is this the ‘Annual Portfolio Charge’ field that I have to fill in?

Their responses were:

1. Net Yield is annual return of your selected portfolio after all the expenses over the selected period, whereas the Reduction in Yield is the total % in annual growth that is lowered by the contribution to the expense (Adviser fee, Platform fee, Portfolio fee and such). So, if your portfolio's assumed annual growth over 5 years is 8.55% for example, and if it's total annual fee is 1.58%, then the Net Yield will be 6.85% over 5 years and the Reduction in Yield will amount to 1.70% over this period.

This means that your portfolio would have grown at a rate of 6.85% over 5 years after all expenses, and the annualised fee would be 1.70%.

2. The Net Yield is the figure which is achieved after deduction of charges on an annual basis. I'll use the above example here in which a portfolio's assumed annual growth is 8.55% - if I were to invest £1,000 in this portfolio, which has an annual Portfolio fee of 0.83%, no Initial fee, an Advise fee of 0.25% and a Platform fee of 0.5%, then at the end of year 1 the Net Yield would be £1,068.47 after the deduction of these charges. Let's work this one out here:

Initial Investment - £1,000
Initial Fee - Nil
Annual Portfolio Fee - £8.30 (0.83%)
Adviser Fee - £2.5 (0.25%)
Platform Fee - £5 (0.5%)

So on day 1, the value of my investment would be £984.2 after deduction of fees (£15.8), and at the end of year 1 when the growth is assumed at 8.55% the value of this portfolio would £1,068.47. Then we will have another deduction of fees, which would be around £16.88, which leaves us with a value of £1,051.59 after 1 year and 1 day.

From there the calculator assumes another growth of 8.55% till the end of year 2, at which point the value would be approximately £1,141.501. As you can guess, there will be another round of fee deduction at this point, and as we continue further the value of this investment at the end of year 3 will be approximately £1,219.80.

This effect of fee which we see in our portfolio here is how the RIY is calculated, and its Net Yield achieved.

3. I believe the above point also answers your question here.

4. [...]the RIY doesn't automatically include the Portfolio Expense of your selected portfolio. If your selected portfolio has an Expense figure in Analytics, then you'll see a small pop-up in the RIY when you are entering the charges. The pop-up will tell you what the current Expense figure is, which you can then enter the 'Annual Portfolio Charge' field.

DanAtkinsonUK

I've asked FE to explain why the annual fees are deducted on day 1 (rather than at the end of the period after growth). I'll share what the outcome is, but do any of you have a reasonable explanation why this is the case? I'd have thought that the calculation should reflect 'reality' as closely as possible in order to be useful.

arongunningham

My calculator doesn't match FE's when I include initial charges - now I know why!

DanAtkinsonUK

The only calculation I can get to match perfectly seems to be no charges annual compounding! We are going to have a call tomorrow ABW to try to get to the bottom of things...

arongunningham

Great, I'll be interested to hear what they say.

Are there are other applications you've found on your travels that do similar calculations?

DanAtkinsonUK

Right! I think I have gotten to the bottom of this with FE having had a chat with them this afternoon. They are all a bit new to the tool and there isn't much documentation about.

What the tool is doing is:

• Initial charges are deducted on day 1 as you expect.
• Annual charges & growth are compounded DAILY in arrears

This means that replicating it in excel is going to be a bit more of a beast. Personally I still think that if we are trying to explain what the costs might be we should be doing monthly compounding of the advice/platform type fees. Compounding the fund charges daily sounds sensible, but the spreadsheet would have to have a line for every day and calculate the fund cost plus any monthly (or indeed annually for sipp fees) charges on the days they crop up.

@arongunningham i've not come across any alternatives at this stage. However i'm sure it could be coded up (well, that's what FE did!) and packaged as an app if someone loved MIFID II enough...

richallum

That's great @DanAtkinsonUK That explains why their RIY is coming out more than the equivalent wrap quote I just looked at.

arongunningham

@DanAtkinsonUK I can probably replicate this to some extent quite quickly by changing the compounding periods on my spreadsheet. The thing I need to think about thereafter though is how to deduct a charge every day, rather than at the end of the year.

Although, it's close enough not to worry about it?!

I also wonder how charges are deducted in reality. It's normally monthly for platform fees and I guess they just take a snapshot of the value at the end of the month - rather than applying a charge against each day?

And investment TER's, I am even less sure how their charges are most commonly applied.

benjaminfabi

Cobs 13 annex 4 part 3 @richallum.

benjaminfabi

@DanAtkinsonUK aren't they compounding daily because fund charges are typically taken daily? Look at the TISA briefing document on mifid ii. It's got a link to the example spreadsheet they produced for their members which looks very useful.

Edit : file should be attached now hopefully

TomLloyd_Read

We have used the TISA spreadsheet and built our models into it. Took some doing still but provides all the information you could want. As you'd expect, the RIY % and £ do not look exactly like the costs and charges part of the spreadsheet and this is the area our advisers seem to be having most issue explaining to clients.

arongunningham

The issue is that compounding growth daily will have a different result than people expect.

In other words, when you saying 'I want to assume 5% growth' - that's an annual figure including any compounding. So if you then compound that figure, you're doing something beyond logic.

If FE are doing this, I would challenge that approach.

Applying reductions daily is fine, so long as that's realistic. I'm not too sure if monthly application of deductions is more common than daily?

richallum

I don't know if they're allowing for compounding in the charges. If a charge is 1% pa and they're applying 1/365% each day then it's being overstated as @arongunningham points out.

If they're allowing for compounding for returns and charges on the same basis it's ok, if it's different it's not.

DanAtkinsonUK

Hi @benjaminfabi
I'm fine with fund charges being modelled daily, but adviser/platform aren't deducted daily and where we have wrapper costs these vary between quarterly/annually so compounding them daily won't reflect reality.

Hi @arongunningham you would work out what the non-compounded rate (as part of the calc) using the formula that has a ^ in it rather than simply dividing by 365.

This formula is:

=((1+growthrate)^(1/365))-1

benjaminfabi

Aren't most platform charges calculated daily but simply deducted less frequently (like bank overdraft charges?

This is all academic anyway. However you calculate the monetary amount you can add a line that says "actual figures may differ from the other documents you receive due to slight differences in the calculation methods". RIY in cobs and mifid ii is to one decimal place so the disclosure figure is rarely going to be affected by a different compound period on one of the charges.

arongunningham

@benjaminfabi said:
Aren't most platform charges calculated daily but simply deducted less frequently (like bank overdraft charges?

Either that or they take a snapshot at the end of the month and multiply it by a 12th of the fee. Not sure to be honest and like you, it's not too important. We're not perfectionists... are we?

DanAtkinsonUK

That's a good point. Not worth being a perfectionist with this - especially when we know that returns aren't linear (unless it's a ponzi scheme!)...
Thanks @benjaminfabi - the voice of reason. Whether fees accrue daily with monthly deduction or based on a month end snapshot (or I think some even look at average value over the month) is a bit of a digression.
@arongunningham I think you were missing a emoji from the end of your message there!

richallum

This has been a really good thread. Thanks to everyone who contributed.

DanAtkinsonUK

Exactly what the big tent is designed for! Makes me proud of my profession to be a part of it.