Whether investors know it or not, their asset manager may well be ripping them off. Though fees charged on unit trust investments need not be complicated or high, too often they are both. And these charges are eating away at people’s investment returns.
If an investment is earning an after-inflation return of 6%/year and costs 1% in fees, the investor is losing 17% of that return (1% divided by 6% or 1% of 6%) each year to fees. This compounds over time, eroding investment returns. (All fees quoted in this article exclude Vat.)
"The [investment] industry is structured in a way that is disempowering and confusing, and pushes people into a very expensive model," says Steven Nathan, CEO of 10X Investments.
"Always ask yourself: who is charging me this fee, for what service, and how am I paying for it?" Nathan says.
"Any discussion about fees must be held in the context of returns. Get the 6% real return at the lowest cost."
Unit trusts generally have three major categories of fees: platform fees, asset management fees and advice fees.
* Platform fees
Linked investment service providers (Lisps), such as Allan Gray and Stanlib, enable you to invest in a wide range of unit trust funds through their single platform. They charge a platform fee for this service, which is generally waived if you invest only in their funds.
If you invest by means of a straightforward monthly debit order, you can avoid Lisp charges by going directly to an asset manager and investing in its unit trust funds, says Warren Ingram, executive director at Galileo Capital.
"As assets grow, it might make sense to aggregate them [later] onto one platform, as fees fall dramatically once assets exceed R1m, depending on the Lisp," Ingram says.
"If an investor does not have complex asset management needs, Lisps are probably not the most cost effective," agrees Jannie Leach, head of core investments at Nedgroup Investments.
* Asset management fees
According to Ingram, asset management or fund fees, charged on assets under management, could range from 0.3% at the lowest level (generally on a money market or index-tracking fund) to as high as 3.5% on hedge funds and high-equity balanced funds — this would include performance fees.
"I think an investor should expect to pay an annual fund fee of 1%-1.5% and try where possible to avoid performance fees. Try to go for a fixed fee," Ingram says.
This simplifies and reduces the fee structure, which can also be achieved by electing so-called passively managed funds over actively managed funds. The latter tend to be more costly since fund managers are being paid to actively manage the underlying investments in the fund, rather than doing the asset allocation upfront and then leaving the fund to track underlying indices.
The average cost difference between asset management fees on active and passive products ranges from 1% to 1.5%, says Leach.
"If you’re paying an active manager, ensure you’re getting real value.
"If you don’t know, [rather invest in] a passive fund, as it will cost you less and have a long-term performance benefit," Ingram says.
Research by S&P Dow Jones Indices shows that over the five years to December 2015, 74% of domestic equity funds and 96% of global funds managed from SA trailed their benchmarks, indicating a persistent pattern of underperformance by active managers.
* Advice fees
Financial advisers can charge a maximum 3% upfront fee on the amount invested and an annual fee as a percentage of assets under management. Investors should ask their financial advisers what fees they are charging and for what service, and whether these are being charged at their maximum limits.
A person investing R1m whose adviser charges an upfront fee of 3%, has the invested amount immediately cut to R970,000 before investment has even started.
"It is not common practice for advisers to charge these upfront fees, so investors should question their advisers if they see this type of fee," Ingram says.
"I would rather pay a fixed upfront rand amount to an adviser for developing and implementing a plan."
Ingram believes the annual fee correctly provides an adviser with the incentive to ensure the investor’s assets are growing, since the amount is charged on the assets under management.
"What very few people know is that you can negotiate advice fees," says Nathan.
As of October 1, members of the Association for Savings & Investment SA — in other words most life insurers and asset managers — will have to disclose the effective annual cost for each of these categories of fees and for the financial product as a whole, making it easier for consumers and advisers to compare charges on retail investment products.