South Africa’s obsession with fee-based investing began with the introduction of unit trusts in 1965.
Since then investors have been paying to secure the best active managers in a quest to outperform the market. “The market is quite invested in the active management science,” says Vladimir Nedeljkovic, head of exchange traded funds (ETFs) and index products at Absa Capital.
“Our entire infrastructure is built around it — from asset consultants, to pension funds to how investors look at the world.” Investment “alpha” doesn’t come cheap, with annual management fees and performance bonuses quickly whittling away returns.
The less expensive alternative for long-term saversis passive investment based on instruments that mirror the market and deliver returns in line with a chosen index.
Studies show that passive investments outperform their actively managed peers over time. Savers are not taking much notice and continue to pour billions of rands into the country’s predominantly active-managed unit trust industry.
“Perhaps their mindset will change once they realise that the fee structure in actively managed products could cost them half of total potential returns over time,” says Kari van Rensburg, a director at Sandtonbased Deutsche Securities. The argument for passive funds over actively managed funds is quite compelling.
In her article titled “Fee drag bigger than you think”, Van Rensburg says those who trusted actively managed equity products to grow their wealth over time would “go cold” when they realise the true impact of fees on their nest egg.
“Investors who think one or two percent in fees does not make much of a difference are deluding themselves,” she says. Deutsche’s 20-year snapshot of net returns on the JSE All Share Index (Alsi) is telling.
It’s research showed that an investment of R100 in an Alsi portfolio through a company that charged current fees of 2% a year (2.28% value-added tax inclusive) would have been worth just R727.31 on June 30 2009. If you paid no fees at all, your investment would have grown to R1 152.39.
“That’s significant erosion — perhaps the difference between retiring in comfort — or retiring with insufficient funds to maintain a decent lifestyle,” says Van Rensburg. The best way for local investors to reduce investment fees is by making use of the various passively managed financial instruments available to them.
A passive investment is one that tracks the return of an index by, for example, mirroring the JSE All Share Index. These funds attract fees too, but at fractions of actively managed investments. “Asset managers in the passive funds will have to rebalance their portfolios on a regular basis to track the underlying index and adjust for corporate actions and so on,” says Nedeljkovic.
They apply their skills to minimise the difference between the performance (and net asset value) of the fund and the performance of the index. Until recently an investor had to trawl through hundreds of unit trusts to find a genuine passive investment vehicle.
But now one can choose from the 25 local ETFs offered by the country’s six providers — with promises of more on the way. “We’re working on several ETFs that we want to launch later this year and early 2011,” says Nedeljkovic.
Absa Capital is the country’s largest ETF provider, accounting for 54% of the industry’s R27.3-billion assets under management. The group is also responsible for the country’s most successful ETF to date, New Gold.
Most analysts say the ETF market won’t grow beyond 50 separate products, but there will be plenty of opportunity to snatch capital from the unit trust space. “There are fundamental constraints on the total numbers of ETFs we release to market,” said Nedeljkovic.
“You can have dozens of unit trusts chasing similar strategies, but there’s not much point in offering five different Top 40 Index trackers.” Another ETF constraint is the size of South Africa’s capital markets. There are only 50 liquid shares big enough to create ETF funds over.
So the winners in the ETF space will be those providers that best package the available universe of shares — those implementing the “smart” solutions and adding value for investors. Nerina Visser, head of Beta Solutions at Nedbank Capital, says the local market will probably support between 30 and 40 ETFs.
“In terms of assets the industry could easily double within the next three years,” she says. The local landscape would change drastically if the regulatory environment is softened to allow international ETF providers to duallist on the JSE. “If the global providers begin offering ETFs products over the FTSE, DAX and S&P 500, then there’s no telling what the limits might be.”
Innovation among ETF product providers means the industry can finally shake the long-held “one index only” tag. Deutsche Bank’s range of db x-trackers offers an opportunity for local investors to gain rand-based exposure to shares listed on the American, British and Japanese stock exchanges.
“More people are becoming aware of the fact that these funds afford them offshore exposure without having to use their foreign currency allowance,” says Visser. She commented on the definite move from traditional market capitalisation indices to more innovative combinations of assets.
South Africa’s six ETF product providers and 25 ETF products now make it possible for an investor to tackle the most complex asset allocation exercise, including the requisite exposure to bonds, cash equities and property, using a single financial instrument.
Passive index trackers have also opened the world of precious metal investing to the person in the street. In the past the only way to “buy” physical exposure to gold was through Kruggerrands. Now you can buy New Gold, an ETF backed by physical gold bullion.
Platinum will soon be added to the range of choices. South Africa is playing catchup with the US in terms of assets under management; but we’re right up there where innovation is concerned.
“We listed our gold ETF prior to the US market,” says Nedeljkovic. “And we’re working on some products that haven’t been rolled out internationally.