JOHANNESBURG – Determining what added value you get when you pay above-benchmark investment fees for your collective investment scheme is similar to weighing the cost-effectiveness of a luxury German sedan against a Korean family car.
Will you get enough additional value from the investment to compensate you for the extra money you have to pay? Put simply, will you get bang for your buck?
If a fund delivers a 100% return during a particular year, an investor will probably have no problem sacrificing 10% of the return in fees. But if the return was 11%, forfeiting 10 percentage points in costs would make no sense.
This is probably the most important point in evaluating the fees you pay for your collective investment, says Pankie Kellerman, chief executive officer of Gryphon Asset Management. It is not about the absolute quantum you pay, but about what you buy for it.
The impact of costs
Calculations compiled by Itransact suggest that if an amount of R100 000 was invested over 20 years at an investment return of 15% per annum (inflation is an assumed 6%) at a cost of 1%, the investor would lose 17% of his returns as a result of fees. If costs climb to 3%, the investor would sacrifice almost 42% of his returns.
Unfortunately, it is not always that easy to get a clear sense of what you pay and what it is you pay for, but the introduction of the Effective Annual Cost (EAC), a standard that outlines how retail product costs are disclosed to investors should make this easier.
Shaun Levitan, chief operating officer of liability-driven investment manager Colourfield, says the time spent looking around for a reduced cost is time worth allocating.
“I think that any purchase decision needs to consider costs, but there comes a point at which you get what you pay for.”
You don’t want to be in a situation where managers or providers are lowering their fees but in so doing are sacrificing on the quality of the offering, he says.
“There tends to be a focus by everyone on costs and [they do] not necessarily understand the value-add that a manager may provide. Just because someone is more expensive doesn’t mean that you are not getting value for what you pay and I think that is the difficulty.”
Costs over time
Despite increased competition and efforts by local regulators to lower costs over the last decade, particularly in the retirement industry, fees haven’t come down a significant degree.
Figures shared at a recent Absa Investment Conference, suggest that the median South African multi-asset fund had a total expense ratio (TER) of 1.62% in 2015, compared to 1.67% in 2007. The maximum charge in the same category increased from 3.35% in 2007 to 4.76% in 2015. The minimum fee reduced quite significantly however from 1.04% to 0.44%.
Lance Solms, head of Itransact, says the reason fees remain relatively high, is because customers are not asking active managers to reduce their fees. He argues that it is easier for investors to stick to well-known brands, even if they have access to products that offer the same return at a cheaper fee.
And despite a flood of communication regarding fees, intermediaries are not yet as sensitive about costs as one would have hoped, Kellerman adds.
But there are also other factors to consider.
Although more rigorous regulatory oversight in itself is not necessarily a bad thing, compliance requirements have resulted in significant cost implications for the entire value chain, Kellerman says.
Yet, he does not believe that the focus on costs is overdone. The problem is that the value-chain includes various parties whose interests may differ from those of the client. These include the linked investment service providers (Lisp platforms), brokers, multi-managers and fund managers.
The hope is that the introduction of the Retail Distribution Review (RDR) would eliminate conflicts of interests and frame costs in a different perspective.
At this stage, the extent to which clients put pressure on managers to lower fees is still very limited, he says.
“Do clients get value for money? I think the answer to that question is relatively simple. The answer is no.”
What are you paying for?
Kellerman says ultimately the question is not which product is the cheapest, but rather what added value investors receive for the price they pay.
Do investors really get the opportunity to participate in the upside? Does the money paid to the financial advisor positively contribute to the portfolio earnings? Is the Lisp’s product list biased towards the holding company’s products or does it offer independent, well-researched recommendations?
In deciding whether the fees paid are justified, investors have to ensure the right benchmarks are in place, Levitan adds.
Trying to access the cheapest investment for the sake of it is a case of “the tail wagging the dog”.
The consideration should rather be what goal the investor is trying to fund. The next steps would be to come up with the right equity or fixed income benchmarks and to find a manager that will be able to predictably provide returns in line with or in excess of those benchmarks over time, he argues.
“I do tend to think that we have become an industry that is focused on cost, whereas I’d like us to be an industry that is focused on goals and objectives with cost an important part of the conversation,” he says.
Kellerman says there is a meaningful difference between fees that are automatically deducted and paid to the service provider (typically a percentage of the investment) and a rand bill the investor has to foot himself.
Charging fees at the point at which the service is levied (as opposed to charging an overall percentage that is divided between the fund manager, broker, Lisp and potentially also the multi-manager) may assist in placing costs in perspective, he says.
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