You may be investing your money in unit trusts and other investment funds but do you know how much you are paying in fund management fees? Do you know if your fund manager charges an extra performance fee? What does he/she have to do to attain that performance fee and does the fund manager get nothing if they make a loss on that fund for the year?
There are so many questions that investors should ask before they invest in funds. However, if you have investments and have not asked these questions then now is the right time to do so. Angelique Ruzicka interviews David O’Leary director of fund research at Morningstar South Africa about what you can expect when it comes to fees and what you should be asking before you invest in a fund.
1. What fees are applicable to a fund?
“There are a few fees that apply. There is a management fee, a performance fee and VAT and taxes. The Total Expense Ratio (TER) encompasses all these fees. Typically the fees that apply outside of the TER depend on how you purchased the fund. If you got advice from a financial adviser then you have to pay their fee/commission. If you invested in the fund through a platform such as Glacier then you may have to pay LISP (listed investment services provider) fees.
There may also be more charges outside of the TER. One charge that gets excluded from the TER is the fee that you incur when you buy and sell stocks. It’s hard to keep track of these as an investor. It’s not reported on directly.
Another charge is also laid if you want to sell your fund and invest in another. This is to discourage investors from trading too actively as investing in funds should be a medium to long term thing.”
2. What’s the best way to compare funds and how much is charged?
“It’s most convenient to compare TERs. It’s a very standard way of comparing funds.”
3. What is a reasonable TER charge?
“It’s hard to give a typical TER as it depends on the type of fund that you invest in. The less risky an investment the less you should pay in fees. Just to give you an idea though a domestic equity category anything above 3% TER is expensive and the low end charges is anything below 1%; 1.5-2% is average.
“One of the reasons for the variety in charges is that some charge a performance fee while others don’t.”
4. Is it a good thing if a manager has a performance fee to work towards?
“It can be a good thing but I am sceptical. They [performance fees] are supposed to align the interests of the portfolio manager but I think a simpler way to do this would be if the investment manager invests his/her own personal money in the fund. We refer to this as ‘co-investment’. However, this is not a disclosure that is required.
“The reason why I am not in favour of performance fees is because it may encourage the manager to take more risk to achieve that performance fee. So in the end you may get some unintended consequences.”
5. Should investors ask if their managers invest in their own funds?
“I think investors should ask it but they may not get far. It’s only through people demanding it that people will get it. I think fund management companies should reveal whether their managers invest in their own funds as they commonly ask companies that they invest in if their directors buy shares in the companies they run.
6. Do you have any tips for our readers? How should they evaluate funds based on their fees?
“I would say eliminate funds with TERs above 3% as that would be you paying too much in fund fees. If a firm has a performance fees for the manager then ask them how it works. Some [performance fees] can go down to zero while others still impose a minimum charge regardless of performance. Find out what will happen if the fund performs poorly.
“When it comes to historical performance of a fund don’t ignore it completely. I believe it does matter but pay more attention to fees and the stewardship of the company. When I refer to stewardship, the key thing is to find out if the company is transparent when it comes to explaining things to its investor base. Does their website have a clear FAQ section? Is their website or the information they are giving you confusing or not reflected well? There is definitely a correlation between how well firms treat their investors and how well their funds perform. Firms that treat their investors with respect generally do well and are better managed.
“Finally, even if you use an advisor look at your investments, visit the fund management company’s website and know what these funds are doing. Pull up some basic information. Just because you have an advisor doesn’t mean you don’t have to do your own research.”