Balance your costs with the rewards you want

The debate between active and passive investments is a debate that has been inherently part of the industry for a long time. The main reason why people oppose an active strategy is that fees are high and that there is no guarantee that the fund manager will beat the industry benchmark by promised guidelines.

The world is becoming more consumer conscious, and is acutely aware of the need for fair reciprocation between the fees they pay and the result they get. Do active fund managers overcharge for the service that they offer?

The state of investments

Investment company 10X Investments reports that the recently published Morningstar Global Fund Investor Experience 2015 study, which analyses 25 countries offering investment funds, highlights high fees, poor disclosure levels and advisers’ lack of fiduciary duty as some of the key issues plaguing South Africa’s investment industry.

The report reiterates what many studies by Morningstar and others have demonstrated - that the most consistent predictor of a fund’s net performance over time is the level of its annual expenses. Clearly, the best practice from an investor’s viewpoint is to invest in funds with lower annual costs.

“In this regard, Morningstar’s mark seems generous, ranking South Africa joint 5th on fees and expenses,” says Steven Nathan, CEO of 10X Investments. “Granted, referencing just equity funds, our average fund fee of 1.4% is the sixth lowest, but our balanced (multi-asset) funds rank 20th, with an average fund fee of 1.6%.”

Morningstar notes that South African investors pay separately for administration and advice, which can add another 1% to 1.5% to the cost of investing, which “ranks South African fees amongst the highest in the world”.

Disclosure

Nathan adds that as with previous Morningstar reports, South Africa was marked down heavily for poor disclosure scoring a D+.

He says a big concern for Morningstar relates to fee disclosure. “Funds in South Africa rarely include an example of the impact of fees. Trading costs are rarely disclosed in any manner. There is no uniform presentation of fees, making it very difficult for investors to tell what they are paying in total or for each of the various fund expenses.”

Passive interest

This has, over time, increased the interest in passive investment strategies. Mark Davids, Head of Pre-retirement Investments at Liberty Corporate, points out that the perception that passive investing generates lower returns than its active counterpart is being countered by the recent outperformance of passive funds when compared with active funds in South Africa and globally. As a result, passive investing is likely to increasingly find favour as part of a diversified approach.

“A passive investment strategy or index tracking strategy aims to replicate the weighting of a selected index, such as the All Share Index. By simply tracking an index, rather than selecting which stocks are most likely to outperform the overall market, the fund is able to lower the cost of fees charged to the investor, thereby boosting retirement savings over the long term,” says Davids.

Gaining a foothold

The passive investment approach, which started in America in the mid 1970s, now accounts for approximately 20% of investments made by US pension funds. In South Africa, however, the trend has been far slower to gain traction, with less than 5% of retirement fund assets invested passively, excluding government pension assets.

This slow up take is in spite of the fact that within the local asset management industry, only about one in every five asset managers managed to outperform the JSE Share Weighted Index during 2012 and 2014.

“This underperformance of the index has led many investors to doubt the capability of their incumbent active asset manager and question their higher management fees relative to index tracker options, if the fund is not able to beat the very market it is being paid to outperform,” concludes Davids.

Editor’s Thoughts:
There are a lot of factors that influences ones decision to opt for either passive or active investments. High risks mean high rewards. But do these rewards outweigh Morningstar’s assessment on the market and the fact that you may be overpaying for the results you are receiving? Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts [email protected].