Costs a f lash­ing red light for unit trust in­dus­try

Weekend Argus (Saturday Edition) - - GOODHANGOUTS -

This week, the Rag­ing Bull Awards cel­e­brate the col­lec­tive in­vest­ment schemes that pro­vided in­vestors with su­pe­rior per­for­mance over the past year.

Al­lan Gray, which has a re­mark­able track record in South Africa and abroad for pro­vid­ing out­stand­ing re­tur ns, again achieved the dis­tinc­tion of be­ing named the top do­mes­tic col­lec­tive in­vest­ment scheme man­ager.

It is worth­while to re­flect on a few things about the col­lec­tive in­vest­ments in­dus­try.

When Per­sonal Fi­nance was launched al­most 14 years ago, the South African unit trust in­dus­try was still in its in­fancy, even though it had been around since the 1970s. There were a mere 48 funds, com­pared with the 903 col­lec­tive in­vest­ment port­fo­lios avail­able as at De­cem­ber 31 last year.

Back then, the sav­ings of most peo­ple were in the hands of the life as­sur­ance com­pa­nies. But the life com­pa­nies had for years treated most of their cus­tomers with a de­gree of con­tempt. They sold ex­pen­sive and in­flex­i­ble prod­ucts with lit­tle in­vest­ment choice.

Grad­u­ally, in­vestors re­alised that they were be­ing had, non-life as­sur­ance as­set man­age­ment com­pa­nies started to make their mark (mainly by pro­vid­ing in­vestors with su­pe­rior re­turns), the gov­ern­ment in­ter­vened ... and it was a whole new ball game – one in which the life as­sur­ance in­dus­try is still try­ing to play catch-up. Now, the col­lec­tive in­vest­ment schemes in­dus­try con­trols al­most R800 bil­lion.

Granted, many of the col­lec­tive in­vest­ment funds lie within the stables of the life as­sur­ance in­dus­try. But in the main, the life as­sur­ers have to play by the rules of the col­lec­tive in­vest­ment schemes in­dus­try, ex­cept where the funds are un­der­ly­ing in­vest­ments in one of the life com­pa­nies’ pol­icy prod­ucts.

The point I want to make is that in­vestors do get wise. As Abra­ham Lin­coln once said: “You can fool some of the peo­ple some of the time ... but you can­not fool all of the peo­ple all of the time.”

Ef­fec­tively, the life as­sur­ance in­dus­try saw peo­ple’s sav­ings as some­thing to be milked, and in do­ing so it kept on churn­ing out ever more com­pli­cated prod­ucts, de­signed, in my view, more to con­fuse than to help in­vestors.


It wor­ries me that the same is in­creas­ingly be­com­ing the norm in the col­lec­tive in­vest­ment schemes in­dus­try, where costs seem to keep on ris­ing and the funds on of­fer be­come in­creas­ingly ob­tuse.

What I find amaz­ing is that, de­spite the in­creased com­pe­ti­tion, costs have not been re­duced.

What I find even more amaz­ing is that many of the ab­so­lute dogs of the in­dus­try have the high­est fee struc­tures. And many of the dogs are so-called white la­bel bro­ker funds of funds. Th­ese funds are es­tab­lished by fi­nan­cial ad­vis­ers, most of whom do not have proper as­set man­age­ment qual­i­fi­ca­tions, to cream off an ad­di­tional fee from their clients, us­ing the li­cence of a reg­is­tered col­lec­tive in­vest­ment scheme man­age­ment com­pany. For­tu­nately, the Fi­nan­cial Ser­vices Board is tak­ing a long, hard look at this prac­tice.

One of the nasty lit­tle prac­tices that has crept into the col­lec­tive in­vest­ments in­dus­try is per­for­mance fees, which are nor mally charged on top of an an­nual as­set man­age­ment fee, which in turn is based on a per­cent­age of the as­sets un­der man­age­ment. I have two prob­lems with this:

An an­nual as­set man­age­ment fee is al­ready a per­for­mance fee. The bet­ter the in­vest­ment re­turns, the greater the value of the as­sets un­der man­age­ment and the more the as­set man­age­ment com­pany earns.

Most of the per­for­mance fees (de­pend­ing on how they are struc­tured) re­ward the as­set man­ager for how the mar­ket per­forms and not for any par­tic­u­lar skill on the part of the as­set man­ager. In many cases, the per­for­mance fee de­sign al­lows for a fee to be col­lected even where the as­set man­ager has de­tracted from mar­ket per­for­mance.


My fear is that if the col­lec­tive in­vest­ments in­dus­try is not care­ful, it will even­tu­ally suf­fer the same con­sumer back­lash as the life in­dus­try suf­fered. The signs are there al­ready, and they lie in a seg­ment of col­lec­tive in­vest­ments called ex­change traded funds (ETFs).

The size of the South African ETF in­dus­try in­creased sig­nif­i­cantly last year. The mar­ket cap­i­tal­i­sa­tion of ETFs listed on the JSE rose by R11.1 bil­lion to R27.5 bil­lion by the end of De­cem­ber last year. (This amount is in­cluded in the R800 bil­lion man­aged by the col­lec­tive in­vest­ments schemes in­dus­try.)

Mike Brown, the manag­ing di­rec­tor of et­, says the in­crease was due in part to the gen­eral re­cov­ery of the JSE last year, but it was also a re­sult of new cap­i­tal (R8.2 bil­lion) raised by the ETF in­dus­try.

ETFs are col­lec­tive in­vest­ment schemes and they are also se­cu­ri­ties listed on a stock ex­change. ETFs track the per­for mance of other se­cu­ri­ties by link­ing them­selves to and mir­ror­ing var­i­ous in­dices.

The ad­van­tage of ETFs is that in­vestors do not have to try to choose which of the al­most 900 unit trust funds will have bet­ter ac­tive man­age­ment than the oth­ers.

With ETFs, you in ef­fect earn the av­er­age per­for­mance of the mar­ket, nor­mally at a much lower cost than with ac­tively man­aged funds, be­cause ETFs do not have armies of an­a­lysts and port­fo­lio man­agers tak­ing risks on your be­half.

If you want to find out more about how ETFs work and what kinds of funds are avail­able, buy the lat­est edi­tion (first quar­ter 2010) of Per­sonal Fi­nance mag­a­zine, which is on sale at good book shops and re­tail­ers for R24.


Costs most def­i­nitely play a role in how your in­vest­ments per­form. This is il­lus­trated by looking at the re­tur ns of col­lec­tive in­vest­ment schemes, both ETFs and non-ETFs, that track in­dices.

Brown says the per­for mance data for pe­ri­ods up to one year show that the Sa­trix Rafi 40 To­tal Re­turn Port­fo­lio was the stand-out per­former (see the ta­ble). This ETF, which rein­vests div­i­dends into the fund as and when they are re­ceived, re­turned 37.51 per­cent for the 12 months to De­cem­ber 31, 2009.

The ben­e­fit of rein­vest­ing div­i­dends im­me­di­ately, rather than only at the end of each quar­ter, is il­lus­trated by the fact that the Old Mu­tual Rafi 40 unit trust fund, which rein­vests div­i­dends ev­ery quar­ter, re­turned 35.75 per­cent over the same pe­riod. The Old Mu­tual Rafi 40 also has a higher cost base than the Sa­trix Rafi 40 be­cause of its unit trust struc­ture.

The New­Funds (Absa/Plexus) eRafi Over­all SA In­dex ETF, which, like the Old Mu­tual Rafi 40, pays out div­i­dends each quar­ter, but also charges a per­for­mance fee of 20 per­cent, re­turned 31.97 per­cent for the same 12 months.

Brown says that pos­si­bly over time the New­Funds port­fo­lio’s use of what is called an en­hanced in­vest­ment method­ol­ogy will en­able it to pro­vide a more com­pet­i­tive longterm per­for­mance.

Over the six months to De­cem­ber 31, 2009, the New­Funds eRafi SA Re­sources ETF, which has an en­hanced in­vest­ment man­date, com­fort­ably out-per­formed the Sa­trix Resi Port­fo­lio (31.28 per­cent ver­sus 29.21 per­cent), even though the New­Funds ETF has a higher fee. This sug­gests that an en­hanced in­vest­ment ap­proach does add value, be­cause it al­lows for more flex­i­bil­ity when com­pil­ing a port­fo­lio.

But what is quite clear is that the greater the costs, the lower the po­ten­tial per­for­mance will be.

Al­lan Gray does charge sig­nif­i­cant fees, in­clud­ing per­for­mance fees, but it has an en­vi­able track record of el­bow­ing its com­peti­tors out of the way when it comes to sus­tain­able out-per­for­mance.

But when as­set man­agers that pro­vide only run-of-the-mill re­turns charge high fees, the ar­gu­ment for us­ing ETFs, par­tic­u­larly those that do not charge per­for­mance fees, be­comes very strong in­deed.

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