The study confirms our assessment of the local investment industry, and underwrites the 10X business model of providing a simple solution that is low cost, fully transparent on fees and investments, and that has the essential advice that investors need already embedded.
Including advice and platform fees, the 10X funds typically only cost around one-third of the average South African fee rate quoted in the Morningstar report. 10X, in other words, delivers an investment experience well above the South African average and in line with global best practice.
IntroductionMorningstar recently published its ‘Global Fund Investor Experience 20151’ study. The report analyses 25 countries that offer open-ended funds (such as unit trusts in SA) and rates the experience of investors with reference to regulation and taxation, disclosure, fees, distribution and the media. Each category is scored, and then rolled up into a final grade for each country.
In light of these deviations from global best practice, South Africa was awarded a “C” and only ranked joined 17th in the survey. Although the grade is a slight improvement on the previous two surveys (C-), it remains below average. Three countries – Italy, Japan and China – fared worse. Korea and the US scored straight A’s.
Poor disclosureOnce again, South Africa was marked down heavily for poor disclosure (D+). In part this relates to the absence of a formal fund prospectus found in many other parts of the world. Our regulators are addressing this issue: FSB Board Notice 92 of 2014 (effective from May 2015) requires the distribution of a Minimum Disclosure Document (MDD), the rough equivalent of a simplified prospectus document in other countries. The Retail Distribution Review, once implemented, should also improve disclosure.
But presently, investors still rely heavily on the application form. While this form must contain certain information, its size is not restricted, making it harder to identify and find the critical points.
A big concern for Morningstar relates to fee disclosure: “Funds in South Africa rarely include an example of the impact of fees. Trading costs are rarely disclosed in any manner. There is no uniform presentation of fees, making it very difficult for investors to tell what they are paying in total or for each of the various fund expenses.”
High fees and asymmetrical performance feesOn fees and expenses, Morningstar’s mark (B) seems generous, ranking us joint 5th. Granted, referencing just equity funds, our average fund fee of 1,43% is the sixth lowest, but our balanced funds rank 20th, with an average fund fee of 1,63%. The range of fees is also low – in both instances a mere 50 basis points separate the 20th from the 80th percentile. So other considerations should come into play, two in particular.
Firstly, there is the issue of commissions. South Africa, along with the US, Australia and Netherlands is one of the four markets where commission are unbundled, ie quoted separately from the investment fee. Worldwide, the dominant position is that this cost is bundled into the asset management charge.
Australia and the Netherlands have banned commission altogether. In the US, the rate tends to be 0,3% to 0,4%, but elsewhere, it ranges between 0,5% and 1,2%, with an average of around 0,75%. This is also a reasonable number for South Africa. Add in platform fees, and local investors easily pay a further 1% over and above the asset management charge. That makes us the most expensive market, by some margin, on balanced funds, and second most expensive on equity funds.
The second issue is performance fees. Funds in South Africa are permitted to charge so-called “asymmetrical” performance fees – they may levy an additional charge for outperforming a particular benchmark, but without an equal reduction in fees for underperformance.
This practice is as common as it is self-serving. As Morningstar notes, “It is instructive that in the U.S., where performance fees are required to be symmetrical, those fees are exceedingly rare within mutual funds.”
Further, there is no uniform methodology to levy performance fees and can “vary wildly from one firm to the next”. This skews historical expense ratios and typically misrepresents the investor’s likely fee experience going forward.
Further compounding the problem, many asymmetrical performance fees were found to lack appropriate hurdle rates and high-water marks, again to the detriment of the investor. Per the report, “Only a little more than half the markets with performance fees have sufficient disclosure of the terms of the performance fee to enable an investor to estimate this expense.”
We can confidently say that this group excludes South Africa. David McCarthy, retirement policy specialist at National Treasury, famously remarked at the 2013 10X Retirement Fund Conference that even his PhD from Wharton School did not equip him to understand how some providers calculate their performance fees.
Advisors not subject to fiduciary dutySA was rated C+ (joint 15th) for sales and marketing. A key consideration here is whether advisors are required to act in the interest of the investors ahead of themselves (that is, act as a “fiduciary”). Local advisers do not have such a fiduciary duty – the report notes that “Advisors and other fund salespeople in South Africa can make any recommendation they feel is appropriate without considering equivalent products available that are more suitable for the specific investor.”
This in contrast to countries such as UK and Australia which impose higher standards on advisors, and the US, where legislation is being considered to impose a fiduciary standard on all advisors (not just Registered Investment Advisors).
ConclusionThe Morningstar report confirms the key industry weaknesses perceived – and addressed – by 10X Investments. Simply put, the combination of high fees, poor disclosure and advisor’s lack of fiduciary duty creates a vicious circle that does not portend well for investors.
The report also reiterates that “many studies by Morningstar and others have demonstrated that the most consistent predictor of a fund’s net performance over time is the level of its annual expenses. Clearly, the best practice from an investor’s viewpoint is to have access to—and purchase—funds that have lower annual costs.”
10X provides such access through its range of retirement fund and (imminent) unit trust products. The maximum annual fee is 0,90% pa (excl. VAT), declining for fund balances above R1m. On the benefit statement, investors see the earned gross investment return, as well as the fee deducted, both as a percentage and in rand. Total trading expenses (mainly brokerage and tax) are visibly disclosed on the monthly fact sheet (now barely above 0,1% pa). The impact and level of fees is also heavily emphasised in 10X’s financial literature, financial education content and retirement planning tools.
10X’s direct model does not require the involvement of an advisor; and as the essential advice investors need is already embedded in 10X’s one simple solution, such advice is also not necessary. Factoring in this saving, the 10X funds typically only cost around one-third of the average South African fee rate quoted in the Morningstar report (including advice and platform fees).
10X, in other words, delivers an investment experience well above the South African average and in line with global best practice.
*Morningstar is a US company that provides authoritative and independent mutual fund analysis and research.
