It is most apt that Finance Minister Pravin Gordhan should raise both the costs of investment products and the imbalance in knowledge between product suppliers and consumers as issues that need to be included in the government’s programme to create a “a safer financial sector to serve South Africa better”.
The government is clearly concerned about high costs and about financial services companies taking unfair advantage of consumers, because in the end it means that many will be left financially insecure and that more tax money will have to be spent on social security.
Quite simply, investors are still too often being taken to the cleaners by continued high and opaque product cost structures, with some far worse than others.
Over the years, Personal Finance has published various reports on investigations into costs. Of these, the 2004 research undertaken by actuary Rob Rusconi had the most impact.
This week we publish on our front page an analysis of costs by the comparatively new asset management company, 10X Investments (pronounced “ten ex”), which specialises in passive investment. The company offers a range of passively managed retirement products, from umbrella funds for middle-size to small companies through to preservation funds and a recently launched retirement annuity fund for individuals.
There is plenty of evidence that most of us are responsible for our own poverty in retirement – mainly because we do not save for long enough and we withdraw our savings along the way. But costs and information asymmetry are also significant contributors to an impoverished retirement.
A big problem is that few people, including financial advisers, are able to understand the cost structures, and there is no single industry standard to make costs both fully transparent and comparable.
The life assurance industry uses what is called the reduction in yield, which is the amount by which your returns will be reduced by costs on average each year. The unit trust industry uses what is called the total expense ratio (TER), but both systems allow for a bit of ducking and diving.
Neither system shows you what the impact of those costs will be over the long term. The Rusconi research showed that over 40 years, your savings could be up to 50 percent lower than what they might have been if no costs applied. Obviously a no-cost environment is impossible, but a far lower cost one definitely is possible.
Over the past two weeks I have been assessing passively managed (index tracking) funds and their costs. Listed as collective investment schemes, you have two types of tracker funds (investment portfolios that track an index). The one type is a unit trust fund and the other is an exchange traded fund (ETF), which is listed as a security on the JSE.
Let me be clear on one thing. Tracker investments, be they unit trust funds or ETFs, are about the cheapest investment vehicle available and should always be considered.
I have focused on passively managed funds that invest in the top 40 companies listed on the JSE in the same proportion as the companies that make up the index.
The FTSE/JSE Top40 index is compiled on the basis of market capitalisation: the number of shares issued by each company in the index multiplied by its share price. So if a company has a market capitalisation of 12 percent of the index, then that company’s shares will make up 12 percent of the tracker fund portfolio.
One would assume that the costs of the two types of funds would be the same. They are not.
And what makes it worse is that when you look at performance tables you could very well be misled.
A good example of this is to compare the Old Mutual Top 40 unit trust tracker fund with the Satrix40 ETF.
On the performance tables to December 31, 2010, the Satrix fund is shown to out-perform the Old Mutual fund.
Mike Brown, the chief executive of exchange traded fund online facilitator etfsa.co.za, says the Satrix40 generally has a performance edge, which indicates it is probably a lower-cost fund over time.
Not so, says Craig Chambers, the chief executive of Dibanisa, the Old Mutual Investment Group passive management boutique. The problem is that you do not see the total cost to you in the Satrix40 fund’s TER.
The advertised performance of funds is after the deduction of TERs. The TER of the Old Mutual fund is higher than that of the Satrix40 because it includes the costs of its administration platform.
If you invest in the Satrix40 via its investment plan, you will pay an annual administration fee of up to 80 basis points (0.8 percent) of your savings. The accompanying table (left) shows a list of costs as supplied by each company – and incidentally they did not fully agree with each other.
The point is that if there can be such confusion over such simple products, the potential to fool you increases where products are made more complex by an array of upfront and annual charges, such as with many life assurance products, and where those insidious performance fees are brought into play.
The biggest single problem is that there is no way an ordinary investor can compare costs, because the products are structured in so many different ways. Even where there are standardised cost structures provided by an industry sector, they do not include all costs. What makes it worse is that too often you are provided with performance figures without some or even all the costs reflected.
To compound it all, the people flogging products seldom tell you about the cost-effective products. They are incentivised to sell the high-cost investment products, like many of those of the life assurance industry. And their commissions/fees are mostly not included in product cost calculations.
Both the Satrix Investment Plan and Old Mutual allow, with your agreement, a once-off upfront commission up to a maximum of three percent plus VAT and/or up to one percent a year be deducted from your savings. Why financial advisers, very few of whom have any real asset management skills, should be paid more than asset managers has always been beyond me.
The costs you should be interested in are the total costs – adviser fees, platform fees, the whole caboose.
You should then calculate what effect these fees will have on your long-term outcome. So if you investment target is, say, 20 years, your adviser must tell you how much you would receive without any costs over the full period and how much you will receive after all the costs of the products he or she is selling you have been deducted. If you are losing more than 20 percent of your target value you need to start asking some serious questions.
ETFs, including the Satrix40, have a major advantage over unit trusts in that, as listed securities, you can buy them directly as you would any share. If you are investing large amounts directly through a stock broker, particularly an execution-only online broker, this will bring your acquisition costs down. But you need to be confident in making your own investment decisions.
You will not be paying the yearly cost of the linked investment services product company, AOS, that provides the administrative platform for a lot of the ETFs (including that of the Satrix Investment Plan). The annual administration fee of 0.8 percent (calculated daily), decreasing on a sliding scale to 0.4 percent for amounts over R100 000, is high.
However, when dealing with small amounts (less than about R5 000 a deal), going through a stockbroker is not normally cost-effective. Stockbroker costs may be fixed or on a sliding scale and may include a cost per trade, a monthly administration fee and/or a percentage of assets traded or of total assets.
If a stockbroker is more cost-effective than using the AOS platform, you need to shop around for the best and cheapest online broker. The preferable place to start is with your bank or with other banks, all of which offer online share trading.
In conclusion, watch all the costs all of the time. They can do far more damage than most of us realise.