Consumers get a price tag that makes sense

Supermarkets are filled with thousands of products, many of which serve the same purpose.

What distinguishes one product from another is a combination of brand, price and perceived quality. Consumers use a mix of these three factors to determine whether a particular product meets their requirement or not. These factors play a significant roll in the final purchasing decision.

In a similar fashion, money supermarkets are crammed with hundreds of unit trusts. The South African unit trust industry has been growing for years and now offers a staggering 750 locally managed funds. Confronted with so many options, investors are hard pressed to make the right decision where unit trust purchases are concerned. Historically, investors have only been able to make comparisons based on brand and performance. They have been denied access to accurate price comparisons apart from the rather inadequate upfront charges.

Thus the first option to be considered when purchasing unit trusts has been brand. Unit trust funds are strongly branded by the financial institutions offering them. The second option has been to compare the performance of a particular unit trust fund against the fund rankings of other funds in similar categories. Unfortunately investors cannot rely on past performance to give an accurate indication of future performance.

The Association of Collective Investments (ACI) has created another measure to facilitate the decision making process. A new standard which will allow investors to compare unit trusts on a like-for-life cost basis is being introduced.

Introducing the Total Expense Ratio

The Total Expense Ratio (TER) will be calculated and published for unit trusts from 30 April 2007.

It is a comprehensive measure to ensure that unit trust funds disclose all the fees that are incurred within the portfolio. Investors should note that that TER does not include the once-off fees and commissions charged when funds are first committed to the unit trust. Instead, the TER includes management fees, administration costs, custody fees, trustee fees, audit fees, bank charges and taxes incurred while operating the fund. Multi-tiered funds have to include costs incurred on all tiers of the fund.

"As the calculation method is specifically prescribed, direct comparison will be meaningful," says Russel Julie, Director of Transfer Agency at FinSource.

Investors will have to exercise caution when using the TER as funds which are actively traded will in all likelihood exhibit slightly higher TER numbers. If investors prefer aggressive and active management, they may have to place less emphasis on the costs incurred in running the portfolio.

TER adds value to investors in that it is based on the actual costs incurred within each individual unit trust portfolio. Investors will be able to view the TER in fund fact sheets, internet publications, annual unit-holder communications, fund financial statements and fund financial reports.

Promoting pricing transparency

This ACI initiative is an attempt to provide transparent information to investors in the unit trust industry. TER is a measure to enable comparisons between the cost efficiencies of various unit trusts. It is not a measure of performance; but rather one of comparison which can assist investors in making purchasing decisions.

The unit trust industry has for the most part welcomed the ACI initiative. The TER is used in a number of global markets and is a refreshing approach from an industry active in the financial services area. Disclosure of fees, costs and commissions means that problems such as those occurring in the life industry will be avoided. 

Julie concludes: "We welcome the ACI's new standard as a way of improving transparency in the collective investments industry, in line with world standards.  Investors will now know exactly how much of their investment income is spent on costs rather than distributed as income."

Editor's thoughts:
Investors have had access to information about the upfront fees and commissions charged by unit trusts for some time now. Do you think that the introduction of the Total Expense Ratio will change an investor's decision making process? Do investors focus on costs or performance when purchasing unit trusts? Send your thoughts to [email protected]