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Sunday, April 1, 2007
Setting the trend

The Association of Collective Investments (ACI) has requested its members to begin calculating Total Expense Ratios (TER) with effect from 1st April 2007. These ratios are retrospectively calculated expenses, presented as a percentage of the daily weighted average price of units in the fund.

The formula takes into account service fees, bank charges, trustee fees, auditor’s fees and brokerage. It also takes into account the cost of performance fees paid to fund managers, which is a retrospective fee that is notoriously difficult for investors to calculate. The ACI has requested that collective management companies should display a total expense ratio, as well as the performance fee component of the total fees.
Says chief executive of the ACI, Di Turpin, “The unit trust structure, with its focus on disclosure, should now give investors confidence that the industry is continuing to improve on transparency.”
The introduction of TER is mandatory and will enable investors to track their fund’s expenses and compare their costs with all other unit trusts, she explains. The TER must cover actual costs, so there will be no assumptions or projections permitted in making calculations.
“The ACI has introduced tighter governance structures around how performance fees are disclosed. All reporting and disclosure must now be made in a standardised way and in plain English,” she adds.
“The collective industry is poised for accelerated growth in several areas. These include the growing realisation that unit trusts may well be an ideal low cost retirement saving vehicle, and which can offer pension portability and retirement products that do not penalise the investor.”
She comments that the government’s long awaited paper around retirement reform appeared to acknowledge the larger role that products such as unit trusts can play. “Individual retirement funds, proposed in the paper have found favour elsewhere in the world as well, generally in the form of collective investments. The unit trusts governance structures are also much tighter than most retirement fund rules, showing the natural place that they can play in an environment where all are concerned about the safety of their money.”
Ian Dodds, Managing Director of Fundamental Investments, says that the publishing and calculation of Total Expense Ratios would highlight the sometimes disadvantageous benchmarks used by collective investment companies in the past.
“Investors must remember that a higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. Furthermore, the current ratio of a fund is retrospective is not an indication of the future TER.”
Comments Darren Botha of Investment Solutions, “This is an extremely positive move. But caution is needed when comparing TERs and investors must be aware of the value of these numbers in the investment decision-making process.”
While greatly increasing understanding of the cost structure within a portfolio, all investment decisions should be based on the net expected, risk-adjusted return of a portfolio (relative to an individual’s overall portfolio). A concern is that comparing TERs could cloud the process, possibly resulting in investment in underperforming cheap portfolios rather than in ones that are expensive but outperform.
“A major drawback of published expense ratios globally and locally,” he points out, “is that they do not include the upfront costs of investing. While it is practically impossible to include initial fees due to their elastic nature (they are highly negotiable and often work on sliding scales), these costs need to be taken into account when comparing portfolios as they are a significant expense to the investor.
“US studies have showed that portfolio operating expenses increased during the 20-year period, 1979 to 1999, which coincided with a decrease in upfront fees, indicating that managers could have been changing the mechanics of the fees. This trend has been mirrored in SA, with management companies reducing or even eliminating initial fees.”
He says that if TERs become an integral part of the investment decision-making process, managers may be induced into increasing upfront fees while reducing management fees to compare more favourably on surveys and in publications.
“The style of an investment manager, active or passive, will also affect a portfolio’s TER. Investors considering an actively managed equity portfolio must expect higher trading costs than for a passive equity portfolio. Active managers actively seek returns in the market and therefore trade more frequently on their portfolio, incurring additional trading costs.”
Explains the ACI, TERs will not have to be calculated for funds that have been in existence for shorter than a year. It should be noted that a high TER would not necessarily indicate a bad investment choice; as such fund might have outperformed its competitors. Also note that TER is a historical measure and is therefore not always indicative of future costs. Clients should be mindful of not jumping to conclusions in comparing low risk against high risk funds. Lower TER in a lower risk fund may not indicate the right choice for the investment style required by the client.

Meanwhile, the ACI is in the early stages of negotiation with the Investment Management Association (IMASA), the Linked Investment Service Providers Association (LISPA) and major multi managers to integrate their respective association bodies.

Copyright © Insurance Times and Investments® Vol:20.3 1st April, 2007
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