Fees have big impact on returns from unit trust funds
● When an adviser picks a unit trust fund for you, don’t expect the fees charged by the fund to be foremost in their mind. Things like the past performance of the fund, performance relative to a peer group, volatility, the fund manager’s investment style and the fund manager’s tenure will rank as more important to the adviser than the fees you are going to pay.
This is according to research by Shaheed Mohamed, a product development manager at Allan Gray, into how advisers choose funds from a universe of more than 1 350 unit trust funds.
But the impact of fees on an investment is key — and not well-understood by investors.
Consider this example provided by indextracking asset manager 10X: assuming you saved R3 000 a month for 40 years and invested in a high-equity portfolio that delivered inflation plus 6.5% before fees, you would have R5.1-million capital at retirement, if you paid 1% in fees. But if you paid 2% in fees, you would have only R3.8-million at retirement. And if you paid 4% in fees, you would have R2.3-million at retirement.
In this example, the difference between paying 1% and 2% is R1.3-million. The impact of fees on an investment over time is “almost unbelievable”, says Steven Nathan, the CEO of 10X Investments, imploring investors to do the sums and consider the impact of compounding.
When it comes to investment fees, you don’t always get what you pay for, Nathan says. In other words, paying high fees is no guarantee of high investment growth.
But, arguing that their fees are justified by their outperformance, active managers charge fees of up to 2.5% compared to passive managers such as 10X, which charges 0.9% before VAT.
In addition, you could pay an adviser fee as well as an investment platform administration fee, taking your costs to close to 4%.
According to a 2017 study by Morningstar, Fees as a Predictive Tool of Outperformance, South African unit trust funds with lower total expense ratios had a higher chance of succeeding, both in terms of survival and outperformance of their peer group.
The study echoes the results of similar Morningstar research in the US. It found that over a three-year period, the cheapest quartile (25%) of funds had a higher total return “success ratio” and higher average annualised total returns across the categories South Africa multiasset low equity, South Africa multiasset high equity and South Africa equity general.
“The success ratio is defined as the percentage of funds within each respective category quartile that survived and outperformed the category average over the period ending December 2016.”
Over a five-year period, the predictive power of fees was evident, but less discernible, the study says.
It says the effect of fees on performance depends to some extent on the market, industry structure and category of the fund. In strong bull markets, for example, fees are likely to have less absolute impact on fund performance, thereby lowering the predictive power of fees over certain periods.
The good news for investors is that fees — both institutional and retail investment fees — are coming down.
A 2017 analysis by RMI Investment Managers of net expense ratios on unit trust fund investments over the past 10 years shows a reduction in fees of between 17% and 34%. The net expense ratio is the cost of both asset management fees and operating expenses such as custodian fees and distribution fees.
Investors who use investment platforms and advisers have also seen big fee reductions — of about 30% over the past 10 years.
Nathan says the emergence of index investing and low-cost providers has helped lower the average unit trust fee and increased awareness of the fee impact, putting pressure on the rest of the industry.