Keep an eye on those investment costs

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 however implemented a few years ago 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 High-Equity 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 double-layered 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 High-Equity 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.

*Schalk Louw is a portfolio manager at PSG Wealth.

This article originally appeared in the 16 June 2016 edition of finweek. Buy and download the magazine here.