Are you paying too much in unit trust fees?


When a billionaire like Warren Buffett says we shouldn’t waste our money on fees associated with actively managed funds, it’s probably best to sit up and pay attention. He is admired the world over by investment managers, hedge fund managers and financial advisers, who fly in from all over the world to attend the annual general meeting of Buffett’s Berkshire Hathaway.

His annual letters to Berkshire Hathaway’s shareholders often contain Buffett’s pearls of wisdom when it comes to investments and in his latest one he reiterated his wariness of high Wall Street fees, adding that investors were better off with boring, low-cost index funds.

“My calculation, admittedly very rough, is that the search by the elite for superior investment advice has caused them, in aggregate, to waste more than $100 billion [R1.3 trillion] over the past decade. Figure it out: even a 1% fee on a few trillion dollars adds up,” he wrote.

“The bottom line: when trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”

Steven Nathan, the CEO of 10X Investments, which specialises in promoting index tracking funds as part of its investment strategy for clients, shares Buffett’s sentiments and believes few managers are able to beat the markets.

“Just about every fund manager believes they can outperform the market, but [ratings agency] S&P Global’s figures show that the majority of them don’t,” he says.

Increasingly, active managers are finding it hard to justify high fees. According to the latest S&P Indices Versus Active scorecard for South Africa (ending 2016), 72% of actively managed South African equity funds failed to beat the S&P SA DSW Index over a one-year period.

This group’s performance was also poor over three- and five-year periods as 80% and 77%, respectively, underperformed the benchmark. Then, 77% of actively managed global equity funds trailed the S&P Global 1200 Index. This number increased to 96% and 93% over a three- and five-year period.

Meanwhile, for fixed income, the results were mixed. Across all periods analysed, active managers beat their respective benchmarks in the short-term bond category, but not in the diversified/aggregate bond category.

What can you expect to pay in fees?

When faced with these statistics, you’d think all investors would run into the arms of passive fund providers. But according to Old Mutual’s customised solution statistics, South Africans haven’t quite lost their love affair with actively managed funds, and it is unlikely to end soon.

The statistics show that, by 2020, there will be 65% of investments with active managers in South Africa, while 22% will be invested in indexation funds.

The good news, though, is that fee transparency has greatly improved.

In South Africa, fees have been simplified under the Effective Annual Cost standards developed by the Association for Savings and Investment SA.

It is a measure that has been introduced to allow you, the investor, to compare the cost you incur when you invest in different financial products. The Effective Annual Cost standard is expressed as an annualised percentage of your investment amount.

It is made up of four charges:

. The investment management charge;

. The advice charge (what you would pay your financial adviser);

. The administration fee; and

. “Other” fees, which typically consist of remaining charges such as transactional banking, wrap fund and termination charges.

Nathan believes that costs should be as low as possible, and investors should only be charged 1% to 1.5% at most. He explains that, considering that you are generally receiving 10% a year in returns in a long-term balanced portfolio, the fee is 15% of your return.

“But it’s much worse in the long run because of the compounding impact. So you really have to manage your total fees, and you must ensure you are getting value for whatever fees you are paying,” he says.

Will actively managed funds survive?

Elize Botha, the managing director of Old Mutual Unit Trusts, which promotes passive and active funds, says there is still a place for actively managed unit trust funds in the market.

She says that active managers don’t always underperform, and that a sudden event or bull market can skew the performance in favour of the index funds.

“I think fees are often misunderstood. People often look at the total fee and believe it is high,” she says.

“Some think the charges are all relating to the unit trust provider, but they also comprise of advice charges, platform charges and so on.”

Botha points out that Old Mutual Unit Trusts has gone a long way in reducing fees and has done away with performance-related fees in all but one unit trust.

Nathan says that confusion has often arisen when investors find they are still paying performance fees, even though the fund is underperforming. This is because performance fees can be calculated over a number of years.

“Let’s say a fund did really well, then it does badly – because the fees are calculated over, say, three years, you could still pay for performance fees for the period,” he says.

Can you cut the costs?

If you want to invest in actively managed funds, there are ways you can cut costs. For starters, loyalty can save you some money.

Chad Sharrock, a financial adviser at Attieh & Associates, says: “If you invest through an asset management company’s own funds, the fees
would tend to be cheaper.”

You could save on advice fees because it’s not impossible to choose your own funds. However, although the Effective Annual Cost standards have come into effect, which enable you to compare apples to apples, you may still benefit from financial advice, particularly as there are so many unit trusts on the market – reportedly about 1 300 and counting – to choose from.

Finally, you could save by not using a fund platform.

Ultimately, choosing funds with lower charges will most likely ensure out-performance. This is according to Morningstar, which released analysis last year in a report entitled Predictive Power of Fees: Why Mutual Fund Fees Are So Important. It showed that funds with higher charges are not only more likely to underperform, but may shut down all together.

According to Morningstar, using expense ratios to choose funds helped in every asset class and in every quintile from 2010 to 2015.

“For example, in US equity funds, the cheapest quintile had a total return success rate of 62%, compared with 48% for the second-cheapest quintile; then 39% for the middle quintile; 30% for the second-priciest quintile; and 20% for the priciest quintile. So, the cheaper the quintile, the better your chances. All told, cheapest quintile funds were three times as likely to succeed as the priciest quintile,” said the report.

This can only be good news for those who want to invest on the cheap.

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