Passive revolt to Active fees
Over the last decade I have watched the changes in the investment arena with interest. Investment banks and banker’s reputation took a bit of a knock in 2008, and there were some high profile failures like Lehman Brothers – but most of them are still around, perhaps a little more legislated, but still coining it. Why are they still making so much money? Why are the performance bonuses still so high? Is it the fees they get from assets under management? Probably. Also putting portfolios or products together that they can take a slice of whether the market goes up or down. You know what I mean – not unlike bundling sub-prime mortgages that had zero probably of ever being paid back into kosher products rated AAA by the agencies and on-sold to investors who either didn’t know, or didn’t care about the underlying assets. Speculation is still rife. The massive exposure even ‘sensible’ countries like the UK have to Greek bonds is eye-watering – that problem has been around for at least 5 years.
The sub-prime crises didn’t happen overnight. I was in America for a few months in the beginning of 2007 and it was all over the news – yet the global economy didn’t unravel for nearly a year. By November 2007 my colleagues and I were recommending to our clients preserve capital for a few months while things played out, and boy did they play out. Since then we’ve had a good bull-run, with the odd correction and here. In SA we’ve got used to double digit growth from the stock market – over 35% from offshore money. When the market is in double digit growth, even after you’ve taken inflation into account, fees charged on investments are happily paid. Any financial or investment advisor that has taken credit for what the market did ( not them) had better be prepared to take the blame when it corrects. You don’t have to have a smart investment guru to take advantage of a stock market climb – a low cost passive tracker will do the job just as well.
Let’s just look at those fees in more detail. I am just looking at LISPs here not the insurance companies (if you follow my blogs you all know my opinions on investing on insurance platforms). These are Linked Investment Service Providers, and are separate from Insurance Investment platforms. They are structured quite differently, the major difference from a private investor’s perspective is in how the ‘broker’ is remunerated and what ‘early termination penalties’ may apply. Fees are usually applied as a percentage of ‘assets under management’ – not a fixed amount. The there 4 main types of fees on LISPs (and no, your financial advisor doesn’t get them all!)
There is the platform/administration/management fee charged by the ‘platform’ these are the big insurance or investment companies structure. You can liken a platform to like a paper bag into which you can put your assorted ‘sweeties’ called unit trusts (actually called ‘collective investments’ but that new name is just not gaining traction). On the outside of that paper bag (platform) that you’ve wrapped your sweeties (Unit trusts) in, you can get a koki and write “Flexible Investment”, “Retirement Annuity” or “Living Annuity.” That is the fee they charge for doing the paperwork (basically).
Then there is the ‘Asset Manager’ and his fees. That’s the fee for the company who picks the stocks – or even other Asset manager’s unit trusts (UT) – according to the ‘mandate’ (rules) of the UT. This fee can vary quite widely from .25% to over 2%. Popular Unit Trusts with high profile, glitzy commercials inevitably have the higher asset manager fees. Asset managers who put ‘fund of fund’ (FOF) unit trusts together usually have the highest fees of the lot. Not only are there the usual fees, but those Asset manager pile on another fee on-top of that – for managing the managers. At the high end, platform and asset manager fees can hit nearly 4%, before the financial advisor has even added anything.
The average financial advisory fee is 1% (that does to your advisor for putting the portfolio together, ensuring it will meet your objectives, monitoring the performance and giving you the feedback), but this usually drops to 0.5% and .25% when the sums get over several million or the money is in low growth cash/bonds. If you add that 1% to say 3.8% you’re getting 4.8% in fees coming off your investment, irrespective of which way the market goes.
To add insult to injury there is then a variable ‘performance fee’, measured against a subjective ‘benchmark’ that can push that fee well over 5%. The FSB has been insisting on ‘clean’ costing for some new products like the Tax Free savings Accounts (TFA/TESA) – in other words cut out the performance fees. Some of the big asset managers won’t do that and you won’t see their products on TFAs.
This structure is not unique to South Africa, but because our inflation rate is in the 6% range, it only takes a real 4% growth in the stockmarket to push returns into double digits, so when your statement comes through, the growth is still positive. Winning! Not! In the West interest rates are almost zero, and have been for years. The stock markets have been in a bull run – but nothing like the sort of double digit numbers we have been enjoying. When you’re stellar return is 5%, taking a 3.5% knock in fees ( the ‘Total Expense Ratio” or TER as it is called) suddenly it makes the growth a paltry 1.5%. If the stock market tracks sideways – then the return is negative. The JSE is at about zero year on year. It is likely that your Unit trust is negative after fees, and even more negative if you look at ‘real’ return (adjusted for inflation).
Having a stock portfolio is one way to cut through these layers of fees. If you do it yourself there is just the trading fees, and if you have a stockbroker it might also cost you 1% pa. The only problem is that if your portfolio isn’t R5m or so, it isn’t going to be diversified and you could be exposing the capital to more volatility and risk than you would get from a unit trust or ETF. The silent revolt in the West has been away from costly mutual funds ( unit trusts) and toward ‘ETFs’ Electronically Traded Funds that mimic the market. These ETFs can be effectively managed by computer programs ( who don’t ask for performance bonuses). These ETFs have exploded post 2008. You don’t need a ‘smart’ (read expensive) asset manager, just an order-taker once the index that is going to be tracked is decided on. Yes, ETFs are getting more complicated, but at the core a simple tracker is passively managed and doesn’t try to do anything more than be average.
The only reason you pay for an asset manager is to get ‘better than average’ returns. This is where lies, damn lies and statistics play a part in determining the ‘average’. Asset managers call it the ‘benchmark’ – and in many respects that ‘average’ is fudged. One trick is to compare themselves to a ‘basket of peers’ ( other unit trusts like them) – obviously so a nice, clean, fee-free index like the Allshare Index doesn’t tarnish the halo. An ETF is proudly average. It uses the stock market to power the long term growth of the investment. It is passive, not active. It is the Zen of investing. Letting the market breathe in and out but always (for decades and decades) upwards. By using passive funds, even when wrapped in the paper-bag called “Retirement Annuity” can bring the Total Expense ratio down below 1% – and no performance fees (clean costing as they call it). A ‘Retirement Annuity” is a bit of a smarter, more expensive paper bag, for a flexible investment that fee will often come down below .5%.