SA gets an average rating for its investment fees and expenses
Morningstar: in emerging markets, only Thailand gets a better rating
There will always be debate about the fairness of investment management fees. In the days when the industry was dominated by trust companies and private banks, investors were charged professional fees, usually by way of an hourly rate. This may have made sense if the client base was relatively uniform, say a couple of dozen dollar millionaires.
But in the more industrialised environment of the mutual fund it makes more sense to charge an ad valorem fee, which, in most jurisdictions, has settled at about 1% of assets a year. Savers of R500 a month can hardly be expected to pay a R2,000 bill for services rendered.
Morningstar, which measures mutual fund performance, does an annual survey, called rather grandly an “experience study”, of fees and expenses. It covers 26 countries, including SA and other emerging markets such as China, India, South Korea, Mexico, Taiwan and Thailand, as well as all the main developed markets.
Morningstar says it likes regulators that promote transparency and polices misleading statements. In SA, unit trusts may not publish performance data for periods of less than 12 months. This might seem overpaternalistic but a three-month burst of spectacular returns is probably more luck than skill.
Morningstar looks for a low tax burden on investors. Unit trusts are tax-friendly in SA, as it is only on selling units or not reinvesting the dividend that income or capital gains tax is payable. Morningstar also likes a varied distribution system; SA was a pioneer of the fund supermarket, making it easy to buy mutual funds through brokers though there is little professionalism in the direct-sales channels, which lack the energy and innovation of the direct shortterm insurers. But, in particular, Morningstar looks for competitive fund fees. As a caveat it says it does not have the data to measure total fund costs, including financial advice charges. This is a major omission as advisers often take the largest bite of the cake, 1% of assets at a time when mutual fund fees are heading down towards 0.7%.
When financial advice is paid for by separate fee, rather than bundled in the product, many clients have gone for lower cost options, such as index funds.
Some asset managers try to supplement base fees with performance-based fees. Morningstar says it looks favourably on these only in limited circumstances: the structure needs to align management’s interests with clients’; there must be an appropriate benchmark, not one that is too easy to beat; and, ideally, should measure long-term performance. The best alignment is through fulcrum fees, which adjust upwards and downwards in the same direct proportion to any outperformance or underperformance, in the US performance fees must have this symmetrical pattern. In fact, performance fees paid to US mutual funds are rare. You might expect vast Dublin- and Luxembourg-domiciled funds that sell across Europe and much of Asia to be cheaper, as they can pass on economies of scale, but in many cases the local funds are cheaper. It all looks like cartel behaviour. Perhaps, as the big US index houses such as Vanguard and BlackRock get bigger in the retail market, these fund prices will fall.
SA fees and expenses rate as average. In emerging markets, only Thailand gets a better rating. Best performers are the big US and Australia markets, insulated from overseas competition, and the Netherlands, which banned share classes with built-in commission. Worst are Italy and Taiwan. Morningstar says SA’s funds are relatively expensive, with a median cost of 1.6% for asset allocation funds, equity funds at 1.36% and fixed income at 0.85%. It is concerned that performance fees are often not comparable, and there is no obligation to run them on a symmetrical basis.
In some cases, such as the Allan Gray funds in the early days, investors would pay for performance they had not benefited from. New investors would still pay for the performance of the previous three years.
Morningstar refers to initial charges, but the days of paying 5% of every contribution upfront in SA are long gone. Advisers are all pushing for annuity income by charging an annual investment fee, rather than taking a large slug upfront. Competition ensures unit trust management companies waive upfront fees.
Unit trusts are set up for direct sales. According to the Association for Savings and Investment SA (Asisa), 28% of sales are now direct, compared with 33% from intermediaries. Most of the fund classes in SA are “clean priced”, with no builtin fees for brokers.
Australia gets top rating in part because of its lower fees; its asset-allocation funds are barely half the cost of those in SA at 0.9%; equity funds are 1.23% and fixed income 0.6%. Australian funds still pay commission on recurring premium contracts going back to 2013, but this ends in 2021. Australia allows performance fees, but in a more userfriendly way than SA. They must use high water marks, so losses must be recouped before performance fees are charged again. Morningstar says terms of performance fees are more clearly stated.
Australia also gets high praise for supporting exchange-traded funds (ETFs), increasingly popular among self-directed retail investors and getting support from advisers now that the link between advice and product commission has been severed.
In contrast, Italy has very high fees 2.03% in the case of equity funds and both front loads and recurring commission remain industry norms. No-load funds are hard to access as distribution is still dominated by commission-hungry bank brokers. One bright spot is that digital channels now offer ETFs in solutions sold via robo-advisers.
AUSTRALIA GETS TOP RATING WITH LOWER FEES ... ITS ASSETALLOCATION FUNDS ARE BARELY HALF THE COST OF THOSE IN SA
ONE BRIGHT SPOT IS THAT DIGITAL CHANNELS NOW OFFER ETFS IN SOLUTIONS SOLD VIA ROBO-ADVISERS