Expenses eating your investments?
One of the controversial areas in investment is still fees. Regulatory bodies have been aggressively forcing asset managers to disclose fees in a manner that is easily understood by their investors, but concurrently there should be an education program so that those investors, especially the smaller unsophisticated investor, to understand what fees are being charged, and for what. Everyday I come across clients who either are completely obvious to the fees that they are being charged – or assume that the advisor or broker gets it all. The requirement for the disclosure of Total expense ratios (TER) was introduced in April and July 2007. (The Life assurance industry doesn’t call it TER, they call it ‘reduction in yield’)
On any quotes you now get, the fees have to be clearly and prominently displayed, and broken down into the 3 major categories: Platform ( admin) fees, Asset manager fees and Financial advisor fees. The really grey area is ‘performance fees’ – but more about that later. These are collectively measured under what is called TER – Total Expenses ratio, expressed as a percentage. Total costs divided by total assets. Unfortunately in South Africa this is not an ‘all in fee’ and some costs are still ‘hidden’.
Platform or admin fees are the fees paid to the ‘platform’ aka financial institution who is ‘housing’ your investment. This could be a LISP provider (Investec, Alan Grey, Momentum wealth etc), an insurance company (Liberty, Discovery etc) as well as banks and a variety of other Financial Service Providers.
Asset manager fees are paid to the managers of the collective investment or stock portfolio that you have chosen to invest in, for example Coronation Capital Plus, Investec Equity or Stanlib Property. Those asset managers buy the investments that are the core of the investment. A stockbroker is usually also your asset manager. Collective investments are large pools of shares which allow individual and small investors to get the advantage of diversified investments (in equity, property, offshore, bonds, cash) without having to buy the shares themselves. If you want to build your own diversified share portfolio, it will take hundreds of thousands. Most experienced stockbrokers, for example, will not take on a portfolio that is less than R1m. “Fund of Funds” have got a bad reputation for high fees, and are rarely referred to as such anymore, but believe me, they are still there, in full force. Instead of buying the underlying shares in these collective investments, they buy other collective investments and bundle them into one – and charge their own asset manager fees on top of that (of course). The problem is that if the ‘asset manager’ fees in the collective investment can’t be negotiated down, those fees start to spiral out of control.
Financial advisory fees can be held in a number of different ways. When investing on an insurance platform, brokers are still taking upfront commission equal to the entire life of the product on the day the investment starts (retirement annuities, living annuities, endowments etc), resulting in penalties for ‘early termination’. Anyone who follows my posts will know my opinion of these products. On LISP platforms the fees can be in 2 parts – upfront and ongoing. Upfront commission is paid on the lumpsum investment or monthly premium and can range from 0-3.5%. Most ‘platforms’ no longer charge an upfront fee, and planners are dropping it too, unless it is a labour intensive case ( for example retiring from a government fund that requires numerous trips ( or couriers) to the government department as they will only deal in ‘originals’). Ongoing annual fee is charged as a percentage – usually one percent – on the whole asset. This paid to the advisor at 1/12th of the annual fee every month. This fee is for the ongoing management of your portfolio, and if you’re not getting that ongoing communication from your advisor, then you can fire them and replace them with someone else. before you throw the baby out with the bathwater though and decide you don’t need an investment advisor, read this interesting bit of research HERE.
Performance fees are handled separately on ‘fund fact sheets’ and are paid to the asset managers for ‘beating the benchmark’. In other words being ‘better than average’. Wouldn’t it be nice if we all got a bonus when we got things right half of the time? There are a number of problems with this. It is levied on retrospective performance – in other words if you bought the fund today, you are paying for the last 2 year’s performance that you are not getting the advantage of. This can be as high as .5%. Another problem is the setting of low benchmarks, making it easier to beat. Fortunately the industry is cleaning itself up and introducing ‘clean’ funds – uncontaminated by performance fees. Interestingly, The treasury insisted on ‘clean’ funds for the new Tax Exempt Savings Accounts.
So, what is a ‘reasonable’ TER? It makes no sense to pay high fees for poor performance. If you run your eye down the unit trust page found in the Sunday Times for example, you will see that the TERs range from 0.45 to 3.5% with the lower fees coming from ‘income’ funds (high in cash and bonds) or passive trackers like SATRIX that are now also available as Collective investments. Take for example 2 funds invested in the same space – Satrix ALSI (collective investment) and Alan Grey Equity – one at 0.53% the other at 2.28%, a 1.75% difference. Year to date (1/3/2015) Alan Gray is 67th out of 174 and SATRIX, which should be ‘average’ is 18th/174 – in other words most of the funds in the general equity space aren’t even beating a ‘passive fund’ when you’ve deducted their TER!
Actions:Ask for an IRR (Internal rate of return) report on your investment to understand the true performance. Look at the 3 way split on the expenses on your investment – are you paying over the odds in any area? Consider replacing expensive, poor performing funds with passive trackers.
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Author Dawn Ridler