Costs a f lashing red light for unit trust industry
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 etfSA.co.za, 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.
WHAT COSTS CAN DO
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.