RA 101: The Compounding Impact of Costs, Compared

In part four of four, Magda Wierzycka assesses the impact of those fees in three lump sum scenarios…

In the last instalment, I compared costs across three different lump sum circumstances: R100,000, R500,000 and R1,000,000. In the case of most asset managers, the bigger your lump sum, the more ‘moderate’ the fee.

Now it’s time to look at the true impact of those compounding costs in the three scenarios.

EXAMPLE 1: LUMP SUM INVESTMENT OF R100,000 (ALL COSTS INCLUDE VAT)

EXAMPLE 2: LUMP SUM INVESTMENT OF R500,000 (ALL COSTS INCLUDE VAT)

A few things to note when looking at these comparisons: most asset managers pay LISPs “rebates” of approximately 0.25% per annum for making their unit trusts available on the LISP platforms. Most LISPs, such as Allan Gray and Investec IMS, pass those rebates on to investors by offsetting those against administration costs, thus reducing the cost by 0.25% pa. Sygnia’s LISP, where it offers third party unit trusts, does not accept any rebates and instead offers investors the asset management fee reduced by the value of the rebate. Some LISPs choose to keep the rebate in addition to the administration fees quoted above. These rebates have been ignored in the above analysis as, on balance, they are passed onto investors.

Many large financial advisors have negotiated fee discounts for their clients with specific LISPs in exchange for supporting that LISP. However, this presupposes that an investor needs to use a large financial advisor and pay an advice fee. These discounts are not published and have been ignored.

SOME CONCLUSIONS FROM THE ABOVE COMPARISON

All investment performance numbers should be compared on a net-of-all-fees basis. Performance fees detract a lot from ultimate investment returns.

The cost effective nature of index-tracking funds enhances performance by more than an “active” asset management approach. The difference can be dramatic.

Individual active asset managers have a sporting chance of outperforming market indices, but less so on a consistent basis, and even less so after all fees are taken into account.

Choosing winners of the past on the expectation of future outperformance is a dicey game, particularly once implemented as a diversified strategy.

The cost of an RA varies widely between providers and has a significant impact on the annual returns enjoyed by an investor. The same investment strategy (Active Unit Trust) yields very different net returns depending on which RA one chooses. The difference can be as high as 0.50% per annum (more if rebate refunds are taken into account).

I would suggest avoiding any RAs that charge initial, transaction and termination fees. It is just too easy to lose one’s way.

After all of the factors are weighed up, the complexities considered and the costs exposed, a carefully chosen RA underpinned by an index-tracking investment strategy is hard to beat.