Keep an eye on those in­vest­ment costs

As an in­vestor, it is vi­tal to know what fees you are pay­ing, as th­ese can have a mas­sive im­pact on your re­turns.

Finweek English Edition - - MARKETPLACE - Ed­i­to­rial@fin­ is a port­fo­lio man­ager at PSG Wealth.

until re­cently, many lo­cal in­vestors were not in­formed of what fees they were pay­ing. In­vest­ment and in­sur­ance com­pa­nies ex­cused poor re­turns with state­ments such as “an­nu­ities and/or en­dow­ments are bad in­vest­ments”. And yes, in many cases that was the prob­lem. But the point is that we never re­ally knew what we as pri­vate in­vestors were pay­ing for and when­ever in­vest­ments per­formed poorly, the com­pa­nies in­volved were not pre­pared to pro­vide com­pre­hen­sive an­swers.

For­tu­nately, this picture has changed for the pos­i­tive over the last few years, due to the fact that all fees must now be de­clared to in­vestors. In the last 10 years, struc­tures have also changed with the im­ple­men­ta­tion of new-gen­er­a­tion prod­ucts that show you ex­actly what an in­vest­ment will cost you be­fore you sign an ap­pli­ca­tion form. Unit trusts, as well as in­vest­ment and fi­nan­cial ad­viser fees, have also be­come more trans­par­ent, al­low­ing in­vestors the op­por­tu­nity to ne­go­ti­ate those fees.

Orig­i­nally, fund man­agers only in­di­cated their man­age­ment fees as a sin­gle per­cent­age on their fact sheets, now also known as Min­i­mum Dis­clo­sure Doc­u­ments (MDD), while other fees, such as per­for­mance bonus fees, de­manded rel­a­tively lit­tle ex­pla­na­tion on th­ese fact sheets. To­tal Ex­pense Ra­tio (TER), which in­di­cates all fees and charges in­volved in the man­age­ment of the port­fo­lio/fund, was im­ple­mented a few years ago, how­ever, as a com­pul­sory re­quire­ment on unit trusts’ fact sheets.

More re­cently, a new kind of fee has made its ap­pear­ance on unit trusts’ fact sheets, namely Trad­ing Costs (TC). This is a per­cent­age of the value of the fund used to pay for the buy­ing and sell­ing of the fund’s un­der­ly­ing as­sets. To­gether, the TER and the TC is in­di­cated as the To­tal In­vest­ment Cost (TIC) on unit trusts’ fact sheets.

Be­fore I dis­cuss the costs on unit trusts in more de­tail, I need to point out some­thing that can be found on more than 90% of all lo­cal unit trusts’ fact sheets. A higher TER doesn’t nec­es­sar­ily mean lower re­turns, in the same way that a lower TER doesn’t nec­es­sar­ily mean bet­ter re­turns.

Also, just be­cause a TER is high cur­rently, doesn’t mean that it’s go­ing to stay that high for­ever. TC, in turn, is also a very im­por­tant as­pect in man­ag­ing the fund and it can be af­fected by an ar­ray of fac­tors.

When I took a closer look at South African unit trusts, an in­ter­est­ing picture emerged. I fo­cused specif­i­cally on the largest unit trust sec­tor in South Africa, the SA Multi-As­set HighEquity Funds’ To­tal In­vest­ment Costs. My data is based on the fol­low­ing:

Funds of funds and multi-man­aged funds have been ex­cluded, mainly be­cause their TICs would tend to be higher due to its dou­ble­lay­ered struc­ture.

Only funds that in­di­cated their TICs on their fact sheets were in­cluded (I was sur­prised to see many with­out it).

Where more than one fund class was avail­able, I chose A-classes.

Data had to be at least one year old. What a sur­prise it was to see just how big the dif­fer­ence was in av­er­age costs be­tween the five most ex­pen­sive funds vs the five cheap­est funds (3.91% vs 0.79% – see ta­ble). At this point I want to stress again that higher costs don’t nec­es­sar­ily mean that the five most ex­pen­sive fund man­agers (Long Beach, RECM, Per­petua, Con­tego and War­wick) will de­liver lower gross re­turns when com­pared to the 72 cheaper funds that formed part of my anal­y­sis. The im­por­tance of this anal­y­sis lies in the fact that in­vestors should know ex­actly what ex­per­tise and ser­vices they are pay­ing for, so that they are able to com­pare it to what­ever else is avail­able on the mar­ket.

As an ex­am­ple, let’s sug­gest a 45-year-old in­vestor has R1m to in­vest. Let’s also sug­gest that all the avail­able SA Multi-As­set HighEquity Funds de­liver the ex­act same re­turns (although this is nearly im­pos­si­ble) of 11% (ex­pected in­fla­tion of 6% plus 5%) be­fore costs. With the sec­tor’s av­er­age TIC of 2.13%, the in­vestor’s ini­tial R1m in­vest­ment should grow to R5.5m by the time they turn 65. At an av­er­age TIC of 3.91% (av­er­age of the five most ex­pen­sive funds), the same in­vest­ment would grow to only R3.935m over the same pe­riod.

So should TIC be the de­cid­ing fac­tor in your choice to in­vest in a par­tic­u­lar fund? Def­i­nitely not. But don’t stick your head in the sand, think­ing that if you don’t see th­ese costs, they don’t ex­ist.

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