Over the last few years there has been a tremendous amount of focus placed on the fees charged on financial products. Across the industry, there has been growing pressure to deliver the most cost-effective solutions to clients.
The investment industry in particular has come under a lot of pressure, with asset managers being forced to re-evaluate the value they are providing for the fee they are charging. Independent research firm Morningstar has even gone so far as to show that fees are the best determinant of future returns – the lower the fee a fund charges, the more likely it is to outperform.
This week Morningstar released its 2019 Global Investor Experience Study on fees and expenses. This biennial report compares and rates unit trust markets across the world, based on the fees investors are paying.
Two years ago, Morningstar rated South Africa as ‘above average’. For 2019, however, the country slipped back into the ‘average’ category.
“It’s not really a case of South Africa getting worse, but more a case of other countries getting better in terms of the fees they are charging,” says Michael Kruger, investment analyst at Morningstar.
Using asset-weighted medians as a measure, the table below shows how fees on South African funds compare to the three most highly rated countries – Australia, the Netherlands and the USA.
|Asset weighted median fund costs|
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There are a number of factors in other markets that are pushing fees down more quickly than in South Africa. The most significant is the rapid uptake of low-cost, passive products.
“Globally there has been a big move to passive, particularly in the US, where we have now seen assets under management in passive equity funds overtake those of active,” Kruger explains. “Passive investing in South Africa is still relatively small when compared to the large active managers and hasn’t taken a massive foothold in the market yet.”
Another important factor is regulation in many countries that has either directly or indirectly put pressure on fees. This includes the Retail Distribution Review (RDR) in the UK, and steps taken in the Netherlands that require fund companies to move investors into fund classes that do not pay ongoing fees to advisors.
Where South Africa is in line with many other jurisdictions is that investors in general are becoming more aware of what they are paying. This is because of increased scrutiny from the media, regulators and government.
“Investors have realised that minimising costs is very important,” Kruger notes. “They are moving into cheaper products, and this has increased the competition between managers. This has forced active managers in particular to bring down their fees in order to compete.”
However, this hasn’t been as pronounced as Kruger would like. This is particularly the case with the large local managers who have enormous scale benefits, but in many cases aren’t passing these on to their clients.
“There is a point where additional assets under management don’t require incremental costs,” Kruger says. “We would expect managers who have significant assets to decrease the fees that they charge and pass this benefit back to investors, but I don’t think that is happening in the South African environment.”
At the moment, the bigger asset managers still enjoy significant brand recognition and stable market shares, and that gives them pricing power. They have therefore not felt the need to reduce their fees to the extent they could have.
The fact that passive investing has also not yet gained significant traction in South Africa also means these asset managers are not facing the same threat from this part of the market as active managers are in other countries.
Performance fee puzzle
The final area where South Africa clearly lags the lower cost markets is the use of performance fees, and particularly where these are asymmetrical – in other words, where the manager earns a higher fee if the fund performs well, but will never earn below a certain level even when the fund underperforms.
“In the US, firms have moved away from charging performance fees because regulation says you have to use a fulcrum fee – that the manager has to participate in the downside,” Kruger says.
Where Morningstar also finds local performance fees problematic is that they are charged on different structures by different managers, and are generally difficult to understand.
“We sit down and try to work out how each of these fees are calculated, and it’s not easy, so it is very difficult for the person in the street to understand what they are paying,” Kruger notes. “Disclosure on performance fees is generally not great from managers either. The way they explain how they work doesn’t do enough to explain how they are calculated and charged.”
There is also the added complication that when performance fees are levied, what the investor is actually paying can change significantly over time.
“Performance fees can change drastically from year to year,” Kruger points out. “We think cost certainty for investors is probably the best thing at the end of the day. When someone looks at their statement and the fee fluctuates drastically from one period to the next, I don’t think that’s in the best interests of end investors.”