Daylight robbery plaguing SA investment market

“This investment will cost you upward of two million rand.” Jill’s face dropped. Her husband Percy had been let go by one of the big steel companies and she was looking to invest his R4 million pension fund. He had barely turned 50, too young to retire, and she wanted to preserve the money for at least another ten years.

Given the time horizon, her adviser suggested a Balanced High Equity Fund. That seemed reasonable enough, but the attached fees, not so much: an initial fee of 3,42%^[4], an annual advice fee of 1,14%^[5], and annual investment fees of between 2,28% and 4,28% (with a published Total Expense Ratio [TER] of 3,53%)^[6].  

According to Steven Nathan, CEO of 10X Investments, these percentages may seem harmless to the uninitiated, but over ten years the rand numbers are staggering: approximately R136,800 on the initial transfer for initial ‘advice’, R456,000 for ongoing ‘advice’, and R1,412,000 for fund related deductions. The average annual cost per year: R200,000, ignoring any inflationary growth on the portfolio.   

“You’ll be lucky if you come out with the same R4 million in ten years’ time, in today’s money,” warns Nathan.  

Nathan explains that in more technical terms, Jill and Percy would take on 100% of the risk related to their high equity investment, while their service providers would effectively take 100% of the return related to that risk.  

He says that too often the discussion around the impact of high fees appears to be an abstraction, an interesting scientific observation, but of little consequence to the man in the street. A bit like the Higgs boson. “But, the size of the fund used in the illustration above is close to R17 billion, hardly pocket change. The underlying issue is that investors end up paying R600 million in costs every year. That is not just a theory…That’s actually happening.” 

Nathan says that there has been so much public outrage about the R246 million cost of Nkandla, and yet this is only a tiny fraction of the R6 billion the fund used in the above example would cost investors over ten years. 

“But, the fund’s high TER is only one marker of the industry’s machinations,” Nathan points out. 

He explains that the adviser is set to pocket around R600,000 from Jill and Percy’s savings. “It is an absurd amount in any context, let alone for this most simple of recommendations. Yet, still not enough to persuade the broker to take extra care of his clients and recommend a low cost fund.” 

There may be an expectation that the fund’s return compensates for the high cost, says Nathan. “You get what you pay for, right? Actually, no. The fund returned 11,9% pa over the past five years, or 15,4% pa, adding back the 3,53% TER. A comparable balanced high equity index fund, costing a fraction of the price (one-sixth, to be exact) delivered the same return.” 

Yet, the uninformed investor will be happy. The fund’s target return is 4% - 5% above CPI, net of fees, and that is what the fund delivered over those five years. Benchmark exceeded, mission accomplished.  Never mind that the average market return was much higher. 

‘What you don’t know won’t hurt you’ appears to be the sentiment underlying unit trust reporting conventions. Nathan says that returns are reported net of fees. “Supposedly, this allows investors to compare after-fee returns but, more insidiously, it hides the fee impact.” 

If disengaged investors notice that comparable funds delivered better returns, it may elicit some fatalistic regret that they did not own one of those funds instead. “But, it would be a muted response, compared to the outrage they would feel if they realised their fund had matched those (average) returns, and that they simply paid away the difference in fees. Or the blind fury that would engulf them if they worked out their loss in rand terms,” says Nathan. 

High fees, average returns, inappropriate benchmarks, poor disclosure, and mindless advice – this one example showcases many of the investment industry’s failings. “It’s hard to believe that National Treasury issued its discussion paper on fees more than three years ago already, and yet so little has changed,” adds Nathan. 

Here’s a bit of mental gymnastics: if all investors paid lower fees, they would all earn a higher return and, therefore, own more of the market. But, the total value of the market would still be the same. So, who would own less? 

Fees are simply a transfer of wealth, says Nathan. “They convert your savings into other people’s income, who in turn use some of that to fund their own retirement (or most of that, if they earn big bonuses). Your savings ultimately become their savings.” 

“So when a life insurer, the same one incidentally that offers the products used in the illustration, claims that its fund managers invest alongside their clients, then take that with a pinch of salt. They are using your money to do so. Even then it can only be under duress, because there’s no way industry insiders would willingly subject themselves to this daylight robbery,” concludes Nathan.    

[4]Old Mutual Unit Trusts Preservation Funds brochure

[5]Old Mutual Unit Trusts Preservation Funds brochure

[6]Old Mutual Balanced High Equity Fund Fact sheet 29 September 2016