Understanding investment fees
15 minutes In South Africa, there are various fees associated with different types of investments. These fees are typically charged by investment platforms, fund managers, or financial institutions.
It is important to carefully review and understand the fee structures associated with your specific investment products, portfolios and providers. Different investments and providers may have varying fee structures, so it is advisable to compare options and consider the potential impact of fees on your investment returns.
Here are some common fees you, as an individual or as a corporate, may encounter when investing in South Africa:
- Policy fees: Policy fees apply where a client/pension fund holds an investment-linked policy issued by an investment manager and nominates to invest into investment portfolios that underlie the investment-linked policy. In terms of the agreement between a corporate client/pension fund (or policy holder) and the investment manager, the client pays a policy fee that is VAT exempt. The policy fee structures vary depending on the portfolio a client chooses.
- Management fees (or ongoing service charge): This fee is charged by the investment fund or portfolio manager for managing the investment on your behalf. It is usually calculated as a percentage of the total assets under management (AUM). The management fee covers the costs of research, analysis, administration, and monitoring of the investment.
- Initial fees (or initial service charge): Some investment funds, particularly unit trusts and hedge funds, may charge initial fees. These fees are deducted upfront from your investment when you purchase units in the fund. Front-end loads are typically expressed as a percentage of the amount invested.
- Administration (or platform) fees: Some investment platforms or financial institutions charge administration fees for maintaining and servicing your investment account. These fees cover tasks such as account administration, record-keeping, and customer support.
- Performance fees: Certain investment funds, particularly hedge funds or actively managed funds, may charge performance fees. These fees are typically calculated as a percentage of the investment gains achieved above a certain benchmark or target. Performance fees incentivise asset managers to generate higher returns for investors. Read our policy on performance fees <here[JM1] >.
- Advice fees (initial adviser charge and ongoing adviser charge): If you seek professional financial advice or engage the services of a financial adviser, they may charge advisory fees. These fees compensate the adviser for their expertise, guidance, and ongoing support in managing your investments.
- Asset consultant fees: As above but applicable to corporate clients/pension funds that receive financial advice or engage the services of an asset consultant. In some instances, the asset consultant fee is included in the annual policy fee depending on the agreement between the client, asset consultant and investment manager. The client can also request the investment manager to be its calculation agent and authorise it to calculate and deduct the fees payable to the consultant from the fund’s assets. In this case the fee is deducted monthly and is reflected on the fund’s monthly statement with the description ‘asset consulting fee’.
- Additional fees: A fund of funds portfolio is a unit trust that, apart from having assets in liquid form, only invests in other unit trusts that levy their own charges. This could result in higher charges for these unit trusts than the maximum annual service charge. A feeder fund portfolio is a unit trust that, apart from having assets in liquid form, is made up entirely of units in a single portfolio of a unit trust that levies its own charges, which could result in a higher fee structure. This fee is usually included in the annual service charge.
- Underlying global manager fees: If you invest in an offshore portfolio an underlying global manager fee may be payable. This fee is usually included in the management fee or ongoing service charge but shown separately in total expense ratios (TERs).
- Brokerage/Transaction fees: When you buy or sell securities such as stocks, bonds, or exchange-traded funds (ETFs) on the stock exchange, you may incur brokerage or transaction fees. These fees are charged by brokers or brokerage firms for executing trades.
- Custodian fees: If you invest through a third-party custodian or asset management company, you may incur custodian fees. These fees cover the safekeeping and administration of your investment assets.
- Exit fees: Certain investment products, such as long-term savings plans or life insurance policies, may charge exit fees if you withdraw your funds before a specified holding period. Exit fees are intended to discourage early withdrawals and can vary depending on the investment product and the length of time the funds have been invested.
To enable investors to compare the costs of every investment or asset manager they are considering investing with, the Financial Sector Conduct Authority (FSCA) introduced TERs, TCs and TICs.
- Total expense ratio (TER). This includes all the direct expenses associated with running an investment fund. These expenses typically include management fees, performance fees if applicable, trustee and custodian fees, legal fees, audit fees, and other operational expenses like fund administration costs and taxes. One should look through the declared fund manager fee and scrutinise the TER to get the true reflection of the actual cost that has been incurred by investing in a particular fund. The TER is typically taken as an average over a three-year rolling period and annualised to the most recent quarter-end. The TER excludes platform administration fees and adviser fees.
- Transaction costs (TC). This percentage of the value of the portfolio was incurred as costs relating to the buying and selling of the assets underlying the portfolio (stockbroker fees, security transfer tax, STRATE contract fees, exchange rate costs, bond spread costs etc.). TCs are a necessary cost in administering the portfolio and affect its portfolio returns. It should not be considered in isolation, as returns may be affected by many other factors over time, including market returns, the type of financial product, the investment decisions of the investment manager and the TER.
- Total investment costs (TIC). This includes the TER + TCs The TIC will be marginally higher than the TER.
- Effective annual cost (EAC). To get on top of the fee complexity of fees, the industry came up with the Effective Annual Cost or EAC. This effectively refers to the total annual cost paid away by the client in fees. It covers all fee related costs even those note included in the TIC calculations. The EAC includes the TIC + platform administration costs + adviser fees. Typically, the EAC will be a projected cost as a percentage of the investment over numerous future years and specifies four main areas namely, investment management charges, advice charges, administration charges and others. The EAC allows you to compare charges across suppliers, at a product level, and shows the effect of a client exiting an investment over specific periods.
The above costs however are no indication of returns or the quality of the portfolio. A higher or lower TER or TIC has no bearing on whether one portfolio is superior to another. Contrary to popular opinion, lower costs do not automatically lead to better returns as often portrayed.
The same, however, cannot be assumed in the actively managed investment environment. An asset manager who adopts a more active style and who changes the portfolio more often than another will automatically have a higher TIC due to more transaction costs incurred. The same applies to asset managers who adopt derivative strategies to limit risk. These strategies come at an additional cost but should reduce volatility.
It is therefore crucial to consider the TER and TIC in conjunction with historical returns to determine how a particular portfolio fared against its peers over different periods. Remember, past performance has no bearing on future returns.
Take note
Feeling overwhelmed? Your financial adviser can explain the fees payable on your investment product or portfolio in detail to you. They can also calculate the expected charges on your investment and the impact these charges will have on your investment returns. Speak to the experts.
Source: Moneyweb, Investment and performance fees 101, 22 September 2022, Mail&Guardian, How to compare investment fees, 5 April 2019, Alexander Forbes Investments