The small matter of investment costs

Terence Gregory, CEO, Ecsponent

In fact, higher costs can be severely detrimental to investment performance. But not many investors know exactly what they are paying, or what is reasonable. How much is too much when it comes to investment costs?

“Part of the problem in answering this question is that not all fee structures are transparent or match what is claimed at the point of initial investment. For example, some managers charge a performance fee even when markets are performing poorly,” says Terence Gregory, CEO of Ecsponent Limited.

While limiting the downside in a bear market should be rewarded, a benchmark of 3% and actual fund achievement of 4% in a bad year could see a 20% performance fee being charged on the 1% performance above the benchmark. Often before administration and annual management fees. The result for investors will be investment performance far below inflation and inconsistent with the funds’ publicised performance. The real investment value is further eroded through inflation, which means that investors are diminishing wealth instead of building it.

“Fees can also be hidden and difficult to calculate, especially in fund-of-funds structures, so that many investors will not even know they are paying certain fees. While each fee levied may be small in itself, over time the effects of these layers of fees can become significant. Just as investment returns can do wonders with the effects of compounding, so can fees destroy capital through small percentages,” says Gregory.

Using another example, consider two individuals who invest R500,000 into two different unit trusts on the same day. If both funds appreciate by 10% per year before costs, but one person is paying a total annual cost of 3% and the other 1%, after 30 years the first investment will be worth R3.8m while the second would be worth R6.3m.

"That’s a 42% difference in value, or R2.5m. Never has a 2% difference looked so big," he says.

Three kinds of fees

Typically, unit trust investments incur three types of costs: financial advisor fees, administrative or platform fees and investment manager or product fees.

The first type of fee is for performing, drafting and implementing a financial needs analysis, for selecting an investment manager, portfolio construction and performance monitoring. On average, financial advisors charge a once-off fee for the initial work to define and investment strategy and financial plan, and 0.50% to 1.0% as an annual advisory fee.

Administrative or platform fees are charged in relation to a linked investment service provider (LISP). LISPS charge annual administration fees expressed as a percentage of the assets they manage on a client’s behalf. On average, LISPS charge a minimum annual administration fee of 0.50% but it can in some instances be as low as 0.10%.

Investment management fees are typically charged annually as a percentage of managed assets, for the day-to-day management of the investment or fund. On average, a balanced multi-asset class unit trust will charge total investment manager fees amounting to 1.50% per annum, but could be as high as 3.0%.

These levies and fees, when added up together, become what is called the total expense ratio, which is expressed as a percentage of the value of the investor’s portfolio of assets being managed.

“Cheaper is not always better, but armed with a TER to check against fund performance and returns, investors are in a good position to tell whether investing with a more expensive provider was worth it in meeting their investment objectives. You don’t always get what you pay for, when it comes to investing, so it is very important to invest with service providers who not only charge a reasonable amount for their services but are also upfront and transparent about their fee structures,” says Gregory.