EDITORIAL: Fund managers and their fees
The growing international popularity of tracker funds helps to explain why SA investors are paying more
The SA fund management industry is sophisticated, professional, internationally adept … and expensive. The question is whether this expense is justified and if not, are the costs of investing the hard-earned cents of retirees coming down?
In some ways, the second part of the question is the easiest to answer; costs are coming down and respectably fast. Part of the reason is that the SA industry is tightly bound to trends in the international industry, and the megatrend internationally has been a drop in the cost of investing.
That decline, which amounts, loosely speaking to a 50% drop across fund categories over the past decade, is closely linked to the growing popularity of tracker funds. [These] merely follow an industry index of one kind or another, and because they require no discretion on the part of the investors or their agents and are generally much cheaper for that reason.
The growing international popularity of tracker funds helps to explain why SA investors are paying more; there is simply a smaller proportion of SA’s entire investment universe invested in tracker funds. Internationally, tracker funds constitute about 30% of total funds under management. In SA, the exact amount is disputed but is in the region of 8%.
Is there a rational reason why tracker funds are less popular in SA than they are internationally?
One explanation relates to the nature of the market in SA, which is uneven in its sectoral balance. For many years it was dominated by large commodity stocks. Active managers argue that this imbalance, and others which have emerged subsequently, makes investing in tracker funds riskier than it is in much larger markets like those in the US. Investors might be inadvertently more exposed to commodity prices, for example, that would be prudent.
THE MEGATREND INTERNATIONALLY HAS BEEN A DROP IN THE COST OF INVESTING
The second reason why South African investors appear to have stuck with active managers has to do with the history of stock market returns.
In a context in which the market has regularly produced 15% per year returns, as the all share has on average over 20 years, investors were content to stick with the traditional method of investing in discretionary funds. This is a healthy return, handily beating inflation over the same period.
But over the past decade, the all share average return has dropped to 11%, and over the past three years, it dropped to 8%. That’s barely above inflation, and if you add fees on top of that, stock market investors are losing money in real terms. Consequently, there is understandably a new conversation taking place between pension fund managers and fund managers about fees.
Despite the characteristics of the market in SA, tracker funds ought to be more popular in SA than they are because they have several advantages over discretionary funds. The most obvious reason is that fees are lower. But there is another thing; active managers often keep a portion of the fund in cash, notionally to take advantage of opportunities when they arise. But in a rising market, this very often means they lose out against investors who are fully invested.
The most recent Morningstar report that measures the performance of active funds against their passive peers in the US market demonstrates that not only have an embarrassing one third of active fund managers outperformed their passive peers in the last 12 months, but they are actually losing ground. In 2017, just 43% outperformed. The fees fund managers charge is also only one aspect of the total cost to investors. Investors, both institutional and retail, often get charged a brokerage fee, an administration fee and sometimes even trading costs. Retail investors often pay financial managers, essentially for advice. Fund managers also have costs to bear on behalf of the investors, including administration fees paid to the wholesale fund platform, if they use one, and fees to the JSE to provide the indices.
The crucial thing is for investors to have a clear and comparable fee breakdown. The Financial Sector Conduct Authority (previously the Financial Services Board) is already working on this issue and legislation is likely in 2019. In the meantime, investors both institutional and private, need to think more carefully about whether they or their clients would not be better served in cheaper, nondiscretionary portfolios.