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Transparency of investment products questioned

Cape Town - The investment industry is changing.

Investors are increasingly demanding less complex products with transparent structures that allow them to see exactly what they are getting.
 
This applies to the fees involved as well as the structure of the underlying instruments. Investors want to know up front how much they will be paying, what they are paying for, and how they will be earning their returns.
 
In response to calls for institutions to be more transparent, in the UK, a special task force called the Transparency Task Force, has recently concluded research into fee structures. The findings uncovered more than 100 types of costs and charges being routinely applied to pensions and investments, many of which are being hidden from the consumer.

Pension funds, in particular, were exposed to fees including bank set-up costs, tax advice fees, transaction charges and fund administration, legal, compliance and governance fees.
 
Asset managers in the local unit trust industry were the first to make investing more accessible by addressing these issues. Products with clear mandates, lower fees than endowments or individual stock portfolios, and high liquidity have attracted huge amounts of investor money over the last two decades.
 
More recently, there has also been a growing interest in passive investing. The costs are low, and investors take comfort in knowing that they will always earn the return of the index, with a level of principal protection in some cases.
 
They also appreciate that there are high levels of transparency in these products. They can examine the way that the index is constructed and know that these pre-determined rules won't change. This means that they can accurately judge whether the exposure they will be getting is appropriate and suits their risk profile.

Index tracking

Gareth Stobie, managing director at Coreshares, an SA firm that specialises in index tracking investment solutions, says: “When you look at the running costs for unit trusts and for Exchange Traded Funds, they are very much alike and so are the reporting requirements. The same total expense ratio convention applies to both.  However, from an expectations-management, governance and a transparency perspective, the rules based nature of index funds means that the products can be sold to clients and the clients know what they are investing in because they can scrutinise the rules upfront.”
 
The rise of the internet and proliferation of information over the past decade has undoubtedly had an impact. Investors are able to access deep research, read the small print and watch the undulation of their investments (in most cases), all on their phone.
 
These developments have also been of great benefit to financial advisers. They can more accurately describe to investors what they will be paying, and what the risk-return pay-off will look like. This improves both the quality and appropriateness of the advice that they give.
 
This move towards greater transparency has also extended to structured products. These were traditionally opaque investments, and the fee structures could be both very high and extremely complex.
 
The last six years has seen a surge in the number being issued and clarity on pricing is one of the main factors for their increased popularity. While some structured products do still suffer from these issues, there is also now a set of offerings that are some of the most transparent investments available. The benefits to investors are numerous.

Structured products

Structured products provide an excellent method to provide the mass affluent market with investment alternatives, particularly those investors who traditionally shied away from the risks associated with direct share ownership, through the provision of features like principal protection and the ability to use a level of gearing to enhance returns. A further benefit is that anyone buying into these products knows from the outset what the potential outcomes will be.
 
“This is the big advantage of structured products,” says Investec's Japie Lubbe. “We outline with the investor in advance of them giving us their money what the return parameters are.”
 
With Investec's International Titans Basket Limited, for example, prospective investors will know that the product references the MSCI World Index, and will pay investors a minimum of 105% of their initial capital in US dollars after five years.

In other words their initial investment is protected and if the index climbs higher than the 5% investors will enjoy 200% of that upside to a limit of 45%. The maximum that investors will receive is therefore 150% in US dollars of their initial investment.
 
The guaranteed return is established through the use of a bond issued by Investec Bank Limited that will mature at the end of the five-year period at exactly 105% of the initial investment. The potential upside beyond that is provided through a call option on the MSCI Index.
 
“We have taken an industry that used to be extremely opaque and converted it into something that is 100% transparent and fully regulated,” says Lubbe. “It is fully audited and everything is disclosed.”
 
These products are constructed in such a way that the guaranteed returns are offered after fees, not before.

Disclaimer: Fin24 cannot be held liable for any investment decisions made based on the advice given by independent financial service providers. Under the ECT Act and to the fullest extent possible under the applicable law, Fin24 disclaims all responsibility or liability for any damages whatsoever resulting from the use of this site in any manner.

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