Investment Costs -- See the Big Picture -- August 2007

Investment costs
In recent years investment costs and product fees have come under the spotlight . There has been a move towards investment products that are more transparently costed and easier to understand.

Fees have generally reduced over the years as technology and information systems have improved. This has been good news for the average investor, although all the changes and new choices can be quite confusing.

At the outset, let me say that fees are important as they will affect your long-term investment returns to some extent. In my opinion, however, it is far more important to pay attention to your overall investment strategy and financial plan. Big mistakes in these areas can cost you big money over time. Paying slightly higher investment costs for additional diversification or superior investment performance should not keep you awake at night. You should not base a decision primarily on investment costs.

A recent development in the unit trust industry has been the use of the “Total Expense Ratio” (TER). You may have noticed this new measurement and wondered what it is all about. TERs are now published with investment performance figures in the weekend newspapers, as well as in fund fact sheets distributed by the asset management companies.

The TER is a measure of the unit trust fund’s assets that were spent as operating costs. It is measured as a percentage of the daily average value of the fund, calculated over a period of time. Operating costs would include asset management fees (including performance fees), administration costs, custody fees, trustee fees, audit fees and bank charges. These services protect your investment, and you should not be unwilling to pay a reasonable fee for them.

The TER would not include any initial entry investment costs, as these could vary from investor to investor. For example, the financial advice fee would normally depend on the amount of the new investment and the level of the investor’s other assets already under advice. The ongoing annual costs of financial advice would not be included either, for the same reason.

The performance fees that the asset manager may charge are separately disclosed. This helps the investor to differentiate between investment costs that are charged to the fund regardless of performance, and a performance fee that may change significantly from year to year. It is important to understand the basis on which performance fees are charged.

The performance benchmark must be fair and not too easily achieved.

There is some interesting information that has become available through the publication of TERs. Some unit trust funds will have significantly higher TERs than others, and unless they can justify these higher costs through superior long-term investment performance, or increased diversification benefits that result in reduced risk for the investor, they may struggle to attract investment inflows in future.

A “fund of funds” is a good example of a unit trust fund that would probably have a relatively high TER, but may provide the investor with reduced risk through diversifying into a number of underlying investment funds. We would expect TERs to be higher for smaller unit trust funds as the total costs would be split over a smaller number of unit holders. These fund managers would argue, however, that the investment flexibility and benefits of a small fund more than outweigh the relatively higher cost.

Please remember that the TER is not a new cost, it is merely a new way of disclosing information. TERs must always be seen in conjunction with investment performance and diversification. They should not be used as the sole basis for an investment decision. Just like investment performance, published TER figures are historical measurements and may not be indicative of future TER costs.

All this extra information can easily create confusion for the average investor. My advice is to engage an independent, certified financial planner who can provide impartial advice. If you do not have a certified financial planner, visit the website of the Financial Planning Institute on www.fpi.co.za to select one.

Debbie Netto-Jonker, CFP™, is founder of Netto Financial Services and was Financial Planner of the year in 2001.