Calculating Reduction in Yield (RIY) relies on assumptions

The reader wanted to know if the life company was simply making up a figure to retain its clients. "If the company cannot give me an exact figure, why is it allowed to use the figure at all?” she asked.

This is a fair question. Reduction in Yield (RIY) is really an industry standard figure given to show how the total charges will affect the growth-rate of a particular fund. Different rounding assumptions tend to be used, which can result in different figures under different circumstances.

The life assurance industry uses RIY as opposed to TER, which makes it tricky to compare products across industries.

Peter Dempsey, deputy head of ASISA, responds to our reader by highlighting the difference between the Total Expense Ratio (TER) and Reduction in Yield (RIY) of a fund.

"The Total Expense Ratio (TER) is a disclosure measure used to show how much of your unit trust investment goes towards fees and costs. TER is backward looking in that it shows actual past expenses as a percentage of your investment. TERs do not indicate whether a fund is a good or poor performer, but merely how expensive a fund is relative to its performance. The TER therefore makes it easier for a consumer to directly compare the costs of one fund against another.

 

A TER includes all expenses incurred by a portfolio, such as management fees, performance fees, administration costs, trustee fees, audit fees, bank charges and taxes.

The TER does not, however, reflect costs outside of the portfolio such as adviser remuneration (unless the fund is bought via a linked investment services provider, that is, a LISP), upfront costs and annual ongoing administration fees.

 

In addition, the TER usually excludes transaction costs such as stockbroker fees and Securities Transfer Tax. Where asset managers do include them, it has to be explicitly stated that the TER includes transaction costs.

The Reduction in Yield (RIY), on the other hand, is a forward-looking disclosure measure. Its aim is to express the various charges on a policy as a percentage of the annual return that will be achieved on the underlying assets.

The RIY will show the policyholder how much of the gross yield (total return) is sacrificed to cover all the expenses charged against the policy.

In order to calculate the RIY certain assumptions have to be made. These include:

a) the expected future return;

b) that the expenses to be charged remain the same; and

c) there are no extraordinary charges that could be charged to the product, like a switching fee, where the investor has the right to switch between portfolios.

The advantage of the RIY is that it allows charges to be reflected as a single Rand amount. Its main drawback is that it relies on assumptions of future experiences, most notably the investment return.

In the case of collective investment scheme (CIS) portfolios, legislation restricts reporting of performance to actual performance net of expenses. It also prohibits the forecasting of future performance. An RIY in case of a CIS could contravene these provisions, as the calculation requires an assumed future return. CIS portfolios consequently calculate a TER.”

The compact impact of charges over a period of time is something that should be scrutinised by investors and tricky part about projections is that they are just that – projections.

 

Dempsey notes that ASISA is currently working on a single cost disclosure structure that will apply across the board for collective investment schemes and life insurance policies, which should make life easier for investors. At this stage, ASISA is contemplating a total cost of ownership model. Watch this space.