Fees debate eclipses investment performance amid fundamental shift
New focus is linked with global move to more affordable tracker funds that lack discretionary mandates
The fund management industry is facing a seismic shift, with negotiations over fees eclipsing investment performance as the major talking point for the first time in recent memory. “About time,” many would argue. The new focus on fees takes place against the backdrop of declining fees in the industry worldwide and even recent news that mega US fund manager Fidelity has launched tracker funds with fees slashed to zero. The issue of fee levels is intimately linked with the global move towards tracker funds — funds that have no discretionary mandate and just track a stock market index.
These funds, such as the Satrix funds, typically have very low fee levels and the industry megatrend is towards adopting these funds. They are still in their infancy in SA compared to Europe at perhaps 5% of the total industry, and are tiny compared with those in the US, now at about 30% of funds under management.
“The reason fee levels have become more of an issue is because until a few years ago quantitative easing tended to underpin stock market returns around the world,” says Sygnia CEO Magda Wierzycka. “When clients are earning 15% a year returns, fees of around 1.5% don’t seem that important. But over the past three years market returns in SA have been more or less flat, so investors are taking a renewed interest in other ways of increasing returns, which of course includes fee levels.”
Wierzycka recently announced that she had closed all the firm’s hedge fund products, even though the company has offered these for 13 years, because she says they are really a “ruse” to pocket fees. Other fund managers agree there is now big pressure on fees and a downward trend, but there is a rich debate about whether SA’s fund managers charge higher fees in total than the US or European fund managers.
That depends a little on how they are measured. If fees charged for all local funds available are averaged out, they seem comparable. But on a weighted basis, South Africans are very likely paying more because the take-up of the cheaper tracker funds in SA is lower.
Total fees charged can be an extremely complex issue because financial advisers can and do often charge separately for investment advice, brokerage and fund management, and fees now also often include a success component. How this is measured is a subject of vociferous debate between fund managers.
The complexity of this process tends to disguise the total cost of investment and has led the Financial Sector Conduct Authority (FSCA) ) to suggest it intends introducing regulatory changes called the Retail Distribution Review. This has become yet another hot debating point and new legislation is expected in 2019, although the FSCA has not yet clarified the form these regulations will take. The government has signalled off and on in the past that it is concerned about what fund managers charge in SA, with a major Treasury study released in 2013. This echoed the vociferous views of low-fee-charging fund managers in SA — such as some from Sanlam Investment Management, 10X and Sygnia — that investors don’t appreciate sufficiently the effect high fees can have on long-term investment returns.
The compounded nature of annually charged fees mounts up over the years to the extent that if total fees are 300 basis points — not an unusual fee level in SA — the total ultimate benefit to the investor is most likely only 50% of what they put in, according to an illustration in the Treasury study, “Charges in SA Retirement Funds”.
Since the report, the international context has been changing fast. According to the April newsletter of the Washington-based Investment Company Institute, on average expense ratios for long-term mutual funds (called unit trusts in SA) have declined substantially for more than 20 years. “In 1996, equity mutual fund expense ratios averaged 1.04%, falling to 0.59% in 2017. Hybrid mutual fund expense ratios averaged 0.95% in 1996, falling to 0.7% in 2017. Bond mutual fund expense ratios averaged 0.84% in 1996 compared with 0.48% in 2017.”
The decline in fund fees has been particularly acute since 2010 in the US and has coincided with an enormous increase in fund inflows, suggesting some of the increase is due to greater economies of scale and increased competition for new money. Investment in US mutual funds has increased from $1.5-trillion in 2011 to $2.3-trillion in 2017.
According to fund managers, these trends are also evident locally. “From a pure asset management perspective, globally there is significant pressure downwards on fees, and that is washing into SA. Our market is well connected with global markets; whatever the trends are internationally, we see them locally too,” Prudential Unit Trusts MD Pieter Hugo said.
However, fee levels vary enormously in the US and elsewhere, depending on a range of factors, including the fund type, fund focus, its past performance, whether it is linked to a different product within the same investment stable and, crucially, whether it is offered to retail or institutional investors.
Fund and stock market analysis company Morningstar has provided Business Day with a comprehensive list of expense ratios for all funds in SA, and a cursory glance at this illustrates the huge range in fund prices. The Prescient Africa Fund of Funds C bears the ignominious title of the most expensive fund on the list, with a staggering expense ratio of 5.85%. In Morningstar’s “general equity” category — the largest single subsection — the average expense ratio is 1.48%, and the range is huge: from 0.14% to 3%.
As the Morningstar numbers capture past performance fees, some funds look expensive now, but that may be because they have performed well.
Another way of looking at the issue is to look at how rich fund management companies are. The largest listed fund management company, Coronation, for example, has a net income margin of about 38% — that’s quadruple those of insurance companies and almost double that of most banks.
Discount-styled fund managers complain bitterly that some of the established names have in the past had bonus pools of more than R1bn for a staff complement of fewer than 200. But Pieter Koekemoer, head of personal investments at Coronation, suggests the trend is strongly downward. Koekemoer says of Coronation’s five flagship funds — one equity, three balanced and one income/bond fund — the equity fund’s total expense ratio declined 34% from June 2008 to June 2018. Over the same period, the balanced funds declined a weighted 15% and the income/bond declined 12%.
Coronation’s experience has therefore been fairly similar to the overall US trend, he says. Coronation’s net fee margin is down on 2013, but is only slightly lower than its 10-year average.
But high margins might be short-lived. Sanlam, which now owns Satrix, populiser of the tracker-fund business in SA, says the take-up of passive funds is huge, and the number of players that have entered the market has grown enormously. “The whole conversation has changed,” says Sanlam Investment retail strategy and implementation head Richard Bray.