How to compare investment fees

Investors are becoming increasingly aware of the (catastrophic) effect that high investment fees can have on their retirement lump sum.But this knowledge leads to the next important question: How do we best compare investment fees across products?

To answer this accurately, savvy investors will need to become acquainted with something called the total expense ratio (TER).

Never heard of it? Don’t worry, you’re in good company. Ben Collins who writes a blog at stealthywealth.co.za and uses a pseudonym when speaking publicly, explains what it is.

“The TER represents the cost of running the unit trust or exchange-traded fund (ETF), and includes things like the annual management fee and administrative costs. It is calculated as the total management and administrative cost, divided by the total size of the fund and then expressed as a percentage,” he tells the Mail & Guardian.

Mike Brown, managing director of etfSA.co.za, further details what the calculation includes.

“These measured expenses include asset management and administration fees, custody costs, trustee fees, audit fees, bank charges, taxes, interest rate charges, costs of buying and selling units from investors and scrip [securities] lending costs,” he writes in a published statement.

Collective investment scheme (CIS) funds —such as unit trusts —also have a management charge, which goes to the fund manager to cover the costs of marketing, advertising, staff overheads, and so forth, Brown explains. “These are included in the TER,” he says. “Performance fees, which are charged by an increasing number of actively managed funds, must also be included in TERs. This also applies to multitiered funds —such as fund of funds, white label funds —where performance fees may be deducted at different levels of fund management.”

Most fund fact sheets include the TER, whether you’re looking at an ETF or an actively managed unit trust fund. It’s a useful starting point to compare fees and, for a long time, the TER was considered the gold standard or international benchmark of fee comparison.

But the TER also excludes certain charges and, in some cases, these are significant.

Brown lists the three categories of costs not included in the TER:

l Brokerage costs: “Where a CIS manager actively ‘churns’ the assets in a portfolio in an attempt to generate outperformance of a benchmark, these brokerage charges can be substantial,” says Brown. It’s less of an issue in the case of ETFs, which usually include such costs in the TER because they’re generally only incurred when the scheme changes its portfolio.

l Distribution costs: Costs associated with investment platforms, stockbrokers, the issuer (in the case of unit trusts) and financial advisers.

l Scrip lending income: Unit trusts can lend out the securities in their portfolio to earn additional income, explains Brown. In terms of the Collective Investment Schemes Control Act, this income has to be used for the benefit of investors, “so the manager typically uses such income to reduce the TER”. But be aware of the fine print: the law requires that the expenses incurred in scrip lending must be included in TERs, but not the income generated by such scrip lending.

Because of this, funds have started disclosing transaction costs “which represent the charges the fund incurred for buying into and selling out of positions in the fund,” says Collins. “For example, when a company is kicked out of an index, an ETF that tracks that index will need to sell its holdings. In order to do this the fund needs to pay brokerage costs and so forth. Over the course of the year, the transaction costs (TC) are totalled and expressed as a percentage of the total value of the fund.” Scan your fund fact sheet for the TC acronym — this is what it’s referring to.

The industry now touts a newer, more comprehensive calculation called the total investment charge (TIC). “It is pretty much just the TER and TC added together to express the total value of the fund which has been lost to fees,” says Collins.

If you’re starting to feel like you’re swimming in a sea of acronyms, it can really be distilled to a few bullet points, he says:

l Management fee = cost of managing the fund

l TER = management fee + administrative costs

l TC = transaction costs

l TIC = TER + TC 

The M&G conducted a dipstick survey across some investment houses around TIC charges. Unsurprisingly, unit trusts (comprising actively managed funds) usually charged higher fees than ETFs, which are passive funds that track an index.

The cheapest ETFs

l Satrix 40: One of the cheapest ways to invest on the market, with a TER of 0.1% (ETFs generally don’t charge significant transaction costs, so we can use the TER rather than the TIC as a comparator)

l Sygnia’s S&P 500 ETF: TER is 0.16%

l Ashburton Top 40 ETF: TER is 0.16%

The most expensive ETFs

Sygnia’s Itrixrange of products, including its Euro Stoxx 50, FTSE 100, MSCI Japan and MSCI USA options, all have a TER of 0.86%, which is the highest charge on the local market.

Investment products and their TICs

l Old Mutual’s Classic Investment Collection Fund range: The cheapest TIC was 0.47% (for the Money Market Fund A2) and the most expensive TIC was 2.33% (for the Balanced Fund A3).

l Alexander Forbes Investment Unit Trusts Scheme: The cheapest TIC was 0.55% (for the Conservative Passive Unit Trust Fund). The most expensive TIC was 2.08% for the Flexible Fund of Funds.

l Sanlam: Provides individual fact sheets for each of its funds, making comparisons across all more difficult. One of its cheaper funds was the Sanlam Investment Management Active Income Fund, which had a TIC of 0.47% in 2018. A more expensive fund was its Managed Aggressive Fund of Funds, with a TIC of 0.83% in 2018. 

But wait …unfortunately, the TIC isn’t a catch-all for every fee that you might encounter on your investment journey. Most of us are unwittingly privy to several extra layers of charges.

“The problem is that in many cases, the unit trust or ETF is held inside of a retirement annuity (RA), or tax-free savings account, or a platform, which then charges fees on top of this,” says Collins. “There may be a platform fee, or a product fee (in the case of RAs). And then on top of this, a financial adviser may have put you on to the product, and so they also take their commissions.”

For example, Sanlam’s Managed Aggressive Fund of Funds is described as an “aggressively managed” fund, and charges a TIC of 0.83% which seems reasonable in light of the product. However, it also comprises a litany of management performance fees —a minimum fee of 0.51%, and a maximum fee of 1.42%, depending on the fund’s performance. This takes the fees you’re paying as an investor from 0.83% to 2.25% in a high-performing year. 

Meet the EAC

In an attempt to get on top of this complexity, the industry has come up with its latest measurement, known as the Effective Annual Cost or (and here comes another acronym) EAC.

“This number is meant to represent the total cost per year that you are paying away to fees (so it should catch all admin fees, platform fees, product fees, adviser fees, total expense ratios and transaction costs),” says Collins.

The EAC “allows an investor to compare charges across suppliers, at a product level, and shows the effect of a client exiting an investment over specific periods,” says Alexander Forbes retail best-practice unit specialist Mladen Colic. “If you’re setting up an investment product and need to understand how much the total product fee is, ask for the EAC.”

Make the EAC your new best friend when comparing investment products. If you use a financial adviser, make double sure to scrutinise this figure. “I have heard of many people who have done this, and then come back horrified at the total cost they are paying —sometimes as high as 4%!” says Collins.

“Remember, if you are getting a return of 4% more than inflation and your fees are taking that 4% away each year, you are actually not getting anywhere and just spinning your wheels. In my view, an EAC of more than 1.5% is probably starting to get expensive.”

*Not his real name