This article was first published in the third-quarter 2013 edition of Personal Finance magazine.
Exchange traded products (ETPs) are fairly rapidly changing the investment landscape in South Africa, giving small investors access to a greater range of investment opportunities and, importantly, providing a far cheaper avenue to access those opportunities.
ETPs, which include exchange traded funds (ETFs) and exchange traded notes (ETNs), are securities listed on stock exchanges (see “Definitions”, below). They are increasingly regarded as part of the solution to high costs and the challenge of trying to select from the enormous range of investments.
In its recent policy documents on retirement funding, National Treasury highlighted the need to reduce investment costs as part of the drive to encourage saving. Treasury wants retirement funds to consider including index-tracking products as a way to reduce costs and investment risk.
The growing popularity of ETPs is driving direct and indirect investments on the JSE. Direct investment is also being encouraged by the increased availability of online trading platforms that use sophisticated computer programs to provide investors with comprehensive services.
At the same time, an increasing number of providers of retirement-savings products are granting fund members and pensioners access to ETFs. Retirement funds, with more than R3 trillion in assets under management, and pension products are where most South Africans have the bulk of their savings and investments. Some linked-investment services providers (Lisps), which offer retirement-savings products (retirement annuities and preservation funds) and investment-linked living annuities, are allowing their clients to access securities (including ETPs) listed on the JSE. These Lisps are Hollard, Investment Management Services, Momentum Administration Services, PSG Asset Management Administration Services and Sanlam’s Glacier.
Against the background of low interest rates and warnings of reduced equity returns over the medium term, investment costs and the range of investment opportunities are going to become increasingly important issues.
Costs will have a significant effect on your returns over the medium to long term. Actuary Rob Rusconi, who, in 2004, blew the whistle on the high cost of South African retirement-savings products, calculated that saving one percent in costs every year over 40 years will add 30 percent to your final maturity value.
Despite the massive increase in the choice of investments over the past 20 years, particularly in the collective investment schemes sector, until recently there has been little downward pressure on costs. Instead, product providers have found new ways to make costs opaque, in particular by introducing performance fees on top of the annual fees levied as a percentage of your investment. Performance fees, all too often, result in your paying a fee based on market fluctuations, rather than for asset manager skill.
The launch of ETFs in 2000, with the Satrix range, provided investors who were concerned about the increasing costs of many unit trust funds with a significant channel for comparatively low-cost investing. Passively managed funds are generally the cheapest investment option, but their total cost can be affected by factors such as whether or not they are part of a product wrapper (a life assurance policy), whether or not you invest via an administration platform and commission/advice fees.
Different cost structures apply to passively managed unit trust funds and ETPs, but don’t be misled into thinking that ETPs are always cheaper than passively managed unit trusts. In fact, the reverse may be true; a passively managed unit trust fund could have a lower cost than an ETP, depending on the channel or administrative platform you use to invest.
You should compare the various costs to ensure that you obtain the best deal, which might involve switching from one investment to another, in which case you must take into account any switching fees.
It is often difficult to compare costs. Most costs are stated either as a fixed rand amount or as a percentage of assets. These costs may be levied at different “levels” – for example, for asset management, administration and/or advice – all of them affecting the returns on your savings.
Collective investment schemes use the total expense ratio (TER) to illustrate their costs on a comparative basis. The higher the TER, the higher the costs you will pay.
The returns of a collective investment are shown after the TER has been deducted. (Note: ETNs are not collective investments, so they seldom use TERs to illustrate their costs. ETFs, however, are collective investments and are obliged to use TERs.)
However, TERs do not include all the costs; they are calculated to show investment costs. In the case of unit trusts funds, administration costs are included in the TER, but when ETFs are bought off an administration platform, administration costs are excluded from the TER. As a result, an ETF bought on a investment plan, rather than from a stockbroker, may appear to have performed better than a passively managed unit trust fund.
For example, both the Old Mutual Top 40 unit trust fund and the Satrix 40 ETF are passive investments that track the FTSE/JSE Alsi 40 Index. According to the ProfileData performance figures to March 31 this year, the Satrix ETF out-performed the Old Mutual unit trust over all investment periods.
The TER of the Old Mutual Top 40 Fund, 0.72 percent, is higher than that of the Satrix 40 ETF, 0.46 percent, because the TER of the Old Mutual fund does not have separate acquisition or administration costs if you buy units directly from Old Mutual, whereas the TER of the Satrix 40 ETF excludes the platform administration costs.
Erol Zeki, head of stockbroking at First National Bank Securities, says one of the better ways to compare index-tracking passively managed funds, or to compare unit trust funds, or to compare index-trackers with unit trusts, is to look at their tracking error. A tracking error is the percentage by which a fund deviates from its benchmark. So, if you are comparing funds that track the FTSE/JSE Alsi 40 Index, you should seek out the fund that is consistently closer to the index.
Two things to bear in mind: you must compare like funds, such as two funds that track the Alsi 40 Index, and not, say, an Alsi 40 tracker with a fund that tracks the gold price, and you should not look for the top-performing index-tracker unless you have invested in an enhanced tracker fund.
Then again, you should compare an enhanced tracker fund against another enhanced tracker fund in the same sector, both of which use mathematical solutions (quantitative analysis, commonly known as “quants”) to out-perform an index. Quants analyse factors such as the cash flows, debts and earnings (profits) of different companies to give different weightings to an index – in other words, they buy more or fewer shares of a particular company that is included in an index, based entirely on mathematical consideration, without human interference.
Trackers can be altered by using other criteria. For example, in the large-cap sub-category there are funds such as the Satrix Swix Top 40, which tracks the FTSE/JSE Swix Top 40 Index, which reduces the weight of foreign shareholdings that are included in the index, and the NewFunds Shari’ah Top 40 Index, which excludes the shares of companies that are involved in activities such as gambling and the production and distribution of alcohol.
Looking at the performance of the Old Mutual Top 40 Fund and the Satrix 40 ETF for the five-year period to March 31, 2013, we find that:
* The FTSE/JSE Alsi 40 Index provided an annual average return of 8.15 percent;
* The Satrix 40 ETF was ranked fourth in the large-cap sub-category, with an annual average return of 7.83 percent; and
* The Old Mutual Top 40 Fund was ranked seventh in the large-cap sub-category, with an annual average return of 6.92 percent.
So, of the two funds, the Satrix 40 had the lowest tracking error. In other words, it came closest to doing what it says it does – and if you are investing in a pure tracker fund, that, presumably, is what you want. Of all the straight trackers in the large-cap sub-category, the Satrix 40 had the lowest tracking error.
Tracking errors are caused by more than costs. They are also affected by factors such as the flow of cash into a fund and the timing of the cash flows. Zeki says that, although the tracking errors between the Alsi 40 tracker funds are not great, there have been wide tracking errors when it comes to ETFs that track large global indices.
If you invest in the Satrix 40 via its investment plan, you will pay an annual administration fee of up to 70 basis points (0.7 percent of your savings), plus VAT, on top of the TER, which will make a significant difference to performance. The platform costs are in addition to the Satrix costs.
Advice fees, which can double the costs, are excluded from the TERs of both ETFs and unit trust funds. Advice fees can include a fee of up to three percent of your initial investment and annual fees of up to one percent of your total investment, plus VAT in both cases. These commissions can be negotiated.
Some Lisps and unit trust funds also pay kickbacks to advisers over and above the commissions.
As with all unit trust funds, you can invest in a passively managed unit trust fund either directly or via a financial adviser. You will pay additional costs if you invest through a Lisp platform that allows you to switch between the unit trust funds of different asset management companies. Lisp costs can be as high as two percent of the value of your assets a year.
ETPs can be bought through a stockbroker, or via an investment plan provided by the company that issues the ETP, or an online financial services provider company, such as etfsa.co.za.
Stockbroker costs vary substantially, particularly if you pay for advice, and will depend on the amount that you invest. The cheapest stockbrokers are online.
Here is an example of ETP investment costs using Standard Bank Online, one of the largest online brokers in South Africa, and an administration platform provided by a Lisp called Automated Outsourcing Services (AOS):
* Standard Bank Online charges an administration fee of R60 a month. You are not charged the administration fee after three trades (buying or selling) within a calendar month. Each trade costs 0.5 percent, with a minimum of R50 a trade. This means that a trade of less than R10 000 is not cost-effective, because the cost of 0.5 percent will increase because of the minimum of R50 a trade. The 0.5 percent is negotiable on trades of more than R500 000.
You will also pay the underlying costs of the ETP. As an example of these costs, consider the annual management fees (excluding VAT) on the Satrix 40:
– Up to R500 000: 0.65 percent;
– R500 001 to R1 million: 0.45 percent; and
– More than R1 million: 0.35 percent.
These costs are normally deducted from the dividend or interest income flows of the ETPs.
* Investment plan via AOS. Most sponsors of ETPs offer investment plans that use an administration platform provided by AOS. An investment plan enables you to make comparatively small recurring and/or lump sum investments. For example, with the Satrix 40, the minimum monthly investment is R300 (or a lump sum of R1 000). However, the stockbroking component is only 0.1 percent, against the 0.5 percent of Standard Bank Online.
The annual costs (excluding VAT), on top of the ETP costs (see above), for using the AOS platform for each ETP in which you invest are:
– Up to R500 000: 0.7 percent;
– R500 001 to R1 million: 0.55 percent; and
– Over R1 million: 0.4 percent.
In the United Kingdom, the top fee is about 0.3 percent for a similar service for similar products.
The AOS platform fees, particularly when you invest large amounts, often raise the costs of ETPs above those of passively managed unit trust funds and put them into the ballpark of some of the lower-cost actively managed unit trust funds. This effectively cancels out one of the main selling points of ETPs: that they are low-cost investment vehicles.
AOS recently reduced its annual management fees. But you need to weigh up the advantages of investing comparatively lower amounts via a Lisp platform.
For the sake of simplicity, the costs of AOS and Standard Bank Online, as the two big players in their respective arenas, are compared below. This is not to suggest that Standard Bank is the cheapest online share-trading platform; it all depends on how much you are investing.
If you have ETPs valued at R105 000, the annual fee of Standard Bank Online becomes cheaper than the annual costs of AOS, which, until that point, are lower. But another factor to take into account is that the R105 000 applies to each ETP you have on the AOS platform. Standard Bank Online aggregates all your investments. If you invest in more than one ETP on the AOS platform, the Standard Bank Online platform will become more cost-effective far sooner.
With Standard Bank Online, you need to invest at least R10 000 each time for your investment to be cost-effective, and your total accumulated investments should exceed at least R105 000.
If you are investing an initial lump sum through the online platform, you also need to invest at least R105 000 so you meet the cost-effective minimum. If you have accumulated sufficient capital on an investment plan platform and you wish to transfer to a more cost-effective online platform, it will cost you a once-off fee of R250 per ETF to transfer from the AOS platform to a stockbroker.
Other costs to watch out for are debit order fees and dividend reinvestment costs.
You must also compare the costs of online stockbrokers. Take account of how many transactions you perform a month and the amounts that you invest. Different permutations will have different effects on the costs.
DEFINITIONS
Exchange traded fund (ETF). An ETF is a listed security on a stock exchange that invests in other shares or in commodities. If the investments are in other listed securities, either in South Africa or internationally, they can also be registered as collective investment schemes, offering greater security and tax advantages.
ETFs range from funds that track commodity prices to those that seek to give enhanced performance (the eRafi) or seek to provide different outcomes, such as the Satrix Divi, which tracks companies expected to provide the best dividend flows. There are also ETFs that allow you to track foreign markets, the property market and bonds.
The big attractions of ETFs are:
* Low costs. ETF costs are normally a fraction of the costs of an actively managed unit trust fund. However, unit trust index funds can be equally as cheap, and not all ETFs are cheap: some foreign funds have high charges, and some funds charge performance fees.
* You get the market average. Research has shown that very few fund managers consistently out-perform an index.
* Tax advantages. No tax is paid by the funds. Tax is paid by you only when you receive interest or if you make a capital gain.
Index. An index is a measure of performance of a particular market or market sector. If a company represents 10 percent of the value of a market sector, it will make up 10 percent of the index for that sector. The best-known index locally is the FTSE/JSE All Share Index (Alsi).