High fees, poor disclosure plaguing SA investment industry

Steven Nathan, CEO of 10X Investments.

The recently published Morningstar[2] ‘Global Fund Investor Experience 2015’ study, which analyses 25 countries that offer investment funds, highlights high fees, poor disclosure levels and advisors’ lack of fiduciary duty as some of the key issues plaguing South Africa’s investment industry.

Overall, South Africa was awarded a C and remains below its global peers.

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 (B) 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”. In most other countries investors do not pay separately for administration and advice.

Another issue relates to performance fees. “Funds in South Africa are permitted to charge so-called “asymmetrical” performance fees. This means they may levy an additional charge for outperforming a particular benchmark, but without an equal reduction in fees for underperformance.

“This practice is as common as it is self-serving. As Morningstar notes, ‘It is instructive that in the U.S., where performance fees are required to be symmetrical, those fees are exceedingly rare within mutual funds’.”

Further, Nathan says there is no uniform methodology to levy performance fees and can vary wildly from one firm to the next. “This skews historical expense ratios and typically misrepresents the investor’s likely fee experience going forward. Compounding the problem, many performance fees were found to lack appropriate hurdle rates.

Disclosure

As with past 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.”

Advisors not subject to fiduciary duty

A key consideration for sales practices is whether advisors are required to act in the interest of the investors ahead of themselves, says Nathan.

“Local advisers do not have such a fiduciary duty. Morningstar notes that advisors and other fund salespeople in South Africa can make any recommendation they feel is appropriate without considering equivalent products available that are more suitable for the specific investor.”

He adds that this is compounded by the fact that large financial institutions account for more than half of fund sales, which translates to a greater number of advisors selling in-house products rather than presenting their clients with all possible choices. “South African clients cannot thus expect to receive best independent advice.”

The solution to these challenges

Simply put, the combination of high fees, poor disclosure and advisor’s lack of fiduciary duty creates a vicious circle that does not portend well for investors.

According to Nathan, addressing these issues has been at the core of 10X’s philosophy.

The maximum annual fee on the 10X range of retirement fund products is 0.90% pa (excl. VAT), declining for fund balances above R1m. 10X’s investor statements clearly reflect the gross investment return, fees deducted - both as a percentage and in rands – and the net investment return. Total trading expenses (mainly brokerage and tax) are visibly disclosed on the monthly fact sheet and are now barely above 0.1% pa. The impact and level of fees is also heavily emphasised in 10X’s financial literature, financial education content and retirement planning tools.

In addition, 10X’s model does not require the involvement of an advisor. As the essential advice investors need is already embedded in 10X’s simple solution, ongoing investment advice is not necessary.

Factoring in this saving, the ideal 10X fund typically only costs around one-third of the average South African fees quoted in the Morningstar report, including advice and platform fees.