A Total Expense Ratio (TER) makes it easy for the investor to understand the total costs associated with the management and running of an investment fund, such as a unit trust.
The size of the TER obviously affects investor returns, because costs come out of the fund. It is important to note that a TER is not a new fee, but a means of disclosure – TERs can give you, the investor, a clear picture of cost structure upfront, so you can compare investments. There are no projections involved, though, so future costs are not calculable.
Essentially, the total cost of a fund is divided by the fund’s total assets to arrive at a percentage, which is the TER.
‘TERs are only indicative of the cost structure rather than being the total cost borne by investors and therefore the amount by which the return on their investments is impacted by costs,” says Mike Brown, managing director of etfSA.co.za.
TER costs management fees (like asset management) as well as, say, custody costs, trustee fees, audit fees, bank charges, taxes, interest-rate charges, the costs of buying and selling units from investors and scrip lending costs.
Collective Investment Schemes (CIS) funds (unit trusts) also have a management charge, which goes to the fund manager to cover costs of marketing, advertising, staff and so on. Performance fees are also included in TERs.
What costs are not included?
Brokerage costs
These are more often than not excluded, because these can be substantial. ‘Most index tracking CIS products, like Exchange Traded Funds (ETFs), include brokerage charges because they only change their portfolios when changes in the index dictate this, so the charges are relatively small,” says Brown. However if a fund is actively trading the brokerage costs can be far higher.
Distribution costs
Many investors use the services of financial advisors and their services are paid for by the deduction of upfront fees or trailing commissions or both. Also, Collective Investment Scheme products must be bought or sold through the issuer, investment platforms or stockbrokers.
Distribution costs can be negotiated and therefore vary considerably from client to client, depending on client size and distribution channels used, so they cannot be aggregated for TER purposes.
Scrip Lending Income
‘CIS funds can lend out the scrip in their portfolios to earn additional income,” says Brown. ‘This income has, in terms of the Collective Investment Schemes Control Act, to be used for the benefit of investors, so the manager typically uses such income to reduce the TER.
The Association of Savings and Investments of South Africa (ASISA) Standard on TERs stipulates that the expenses incurred in scrip lending must be included in TERs, but not the income generate by such scrip lending. As a result, CIS funds that engage in scrip lending, like exchange traded funds (ETFs), sometimes disclose two TERs, one before scrip lending income, and the other with the benefits of scrip lending to reduce TERs.”
These figures are disclosed in the quarterly fact sheets published by such product issuers.
High TERs – a warning sign
Brown advises that you bear the following in mind:
– Products with high TERs typically indicate that the active manager is adding a lot of fees for their expertise and this can mean greater risk for the investor, if the manager gets the market wrong.
– The higher the TER, the more likelihood that all the dividends and interest received in the portfolio is taken up paying for the TER, and so the lower the dividend yield to the investor.
– The more layers of management, the higher the TER, as the Guidelines published by ASISA require that the TER reflects all the management loops in a product. So fund of funds, white label and multi-manager products will have higher TERs and are generally avoided by the more astute investor.
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