Price is what you pay. Value is what you get1
By Paul Hutchinson, Sales Manager
The introduction by the Association for Savings and Investment SA (ASISA) of the Total Investment Charge (TIC) as a measure that allows investors and advisors to assess the impact of all charges and expenses incurred in the management of unit trusts, has improved transparency and fee comparability. Importantly though, while the TIC is a relatively new disclosure requirement, the underlying charges and expenses have always been levied and therefore unit trust fund performance has always been after the impact of these charges and expenses.
What is the TIC?
Essentially the Total Investment Charge is the sum of a fund’s Total Expense Ratio (TER) i.e. any expenses incurred in managing the fund (e.g. fixed (and performance, if applicable) management fees, administration costs, custody fees, trustee fees, audit fees, bank charges, etc.) and the fund’s Transaction Costs (TC) i.e. the costs incurred in the buying and selling of the assets in which the fund invests (e.g. brokerage, VAT, Securities Transfer Tax, etc.).
While funds that charge the same annual management fee have similar TERs, their TCs can vary widely. This has raised some interesting questions relating to price paid versus value received.
Consider the TCs for the Investec Opportunity and Managed Funds, which are both balanced (multi-asset high equity) funds:
- Investec Opportunity Fund = 0.03%
- Investec Managed Fund = 0.78%
Does this mean that the Investec Opportunity Fund is a better investment solution for investors? The short answer is no, it is just different!
Understanding different investment philosophies and their impact on TCs
Portfolio managers apply different investment philosophies to managing money, be it Growth, Value, Earnings Revisions, Price Momentum or Quality. While Value and Growth are the more recognisable and better understood investment styles, each has its own unique approach to analysing and selecting assets. Importantly, each approach also impacts on how frequently or infrequently the portfolio manager buys and sells assets and thereby incurs transaction costs on behalf of the fund.
Value investors actively seek stocks they believe the market has undervalued i.e. stocks are selected that trade for less than their intrinsic value
Growth Investors invest in companies that exhibit signs of above-average growth, even if the share price appears expensive in terms of metrics such as price-to-earnings or price-to book ratios
Earnings Revisions investors invest in companies where the expected future earnings are being revised upwards
Price Momentum investors seek to take advantage on the continuance of exiting trends in the market i.e. by investing in an asset that has an upward trending price
Quality Investors invest in companies with outstanding quality characteristics – these companies have hard-to-replicate enduring competitive advantages that create barriers to entry, enabling such companies to sustain high levels of profitability over the long term
The Value and Quality investment styles are more ‘buy-and-hold’ in nature. Funds that are managed accordingly e.g. the Investec Value and Opportunity Funds respectively, tend to have low(er) turnover ratios (as low as 15–20% p.a. for Investec Opportunity) and hence lower TCs. On the other hand, Growth, Earnings Revisions and Price Momentum are all styles which tend to demonstrate an active trading approach, where actively changing the fund as and when market conditions (growth prospects, future earnings or trends) change is a key contributor to long term returns. Funds managed according to one of these styles tend to have above-average turnover ratios and therefore above average TCs.
Importantly, there is no single route to investment success, and a higher or lower TC is not a determinant of long-term fund outperformance.
The following risk/return scatterplot (Figure 1) illustrates that over the long term investing using either an Earnings Revisions (Investec Managed) or a Quality (Investec Opportunity) philosophy would have delivered similar above-average returns. It is the return series path i.e. how they get there that differs, as illustrated in Figure 2 below, which gives a sense on how the different styles behave over time.
Figure 1: 15-year risk versus return scatterplot
Source: Morningstar as at 31.08.17. Returns are calculated on a NAV-to-NAV basis, net of A-class fees, with gross income reinvested. Market indices are gross of fees. Highest and lowest 12 month rolling performance since inception is; Investec Opportunity = 43.8% and -15.7% respectively, and Investec Managed = 47.2% and -23% respectively.
Figure 2: Extreme market conditions give a sense of how different styles behave
Source: Citi Research, Investec Asset Management, Period = January 2007 to December 2009; Long-short style portfolios.
Independent supporting evidence2
The results of Schroders’ research, which challenges the myth that global portfolio turnover results in poorer outcomes for investors as a result of the additional costs it incurs, supports our view articulated above.
Schroders’ concludes; “Our analysis suggests that the presumption that turnover and transaction costs are to the detriment of investors is misguided as it fails to consider whether these costs lead to better or worse outcomes. We find that, on average, high turnover US equity managers have been able to add at least enough value to offset the additional transaction costs they are exposed to. There is no evidence of a significant relationship between turnover and excess returns. What is surprising is that this is true even in small caps where the costs of trading are noticeably higher.”
The value of independent investment advice
In conclusion, a lower TC does not imply nor result in a better investment outcome. It is essential then that advisors and investors confirm that a fund delivers performance over time consistent with its investment mandate and the fund manager’s investment philosophy.
Given the importance of making the correct decision, we strongly recommend that investors seek professional investment advice, tailored to their individual circumstances.
1Benjamin Graham, The Intelligent Investor, 1949.
2Schroders, Churn is not necessarily burn: debunking the myths of portfolio turnover, July 2017.
Collective investment schemes (CIS) are traded at ruling prices and can engage in borrowing, up to 10% of portfolio net asset value to bridge insufficient liquidity, and scrip lending. A schedule of charges, fees and advisor fees is available on request from the Manager, Investec Fund Managers SA (RF) (Pty) Ltd which is registered under the Collective Investment Schemes Control Act. Additional advisor fees may be paid and if so, are subject to the relevant FAIS disclosure requirements. CISs are generally medium to long-term investments and the manager gives no guarantee with respect to the capital or the return of the Fund. Performance shown is that of the Fund and individual investor performance may differ as a result of initial fees, actual investment date, date of any subsequent reinvestment and any dividend withholding tax and past performance is not necessarily a guide to the future. The value of participatory interests (units) may go down as well as up. Performance figures above are based on lump sum investments, using NAV to NAV figures net of fees with gross income reinvested, in South African rands. The value of participatory interests (units) may go down as well as up. Different classes of units apply to the Fund and the information presented is for the most expensive class. Fund valuations and transaction cut-off time are 16h00 SA time each business day. This portfolio may be closed in order to be managed in accordance with the mandate. Fluctuations or movements in exchange rates may cause the value of underlying international investments to go up or down. A higher Total Expense Ratio (TER) does not necessarily imply a poor return, nor does a low TER imply a good return. Where portfolios invest in the participatory interests of foreign collective investment schemes, these may levy additional charges which are included in the relevant TER. The ratio does not include transaction costs. The current TER cannot be regarded as an indication of the future TERs. Fund prices are published each business day in selected media. Additional information on the Fund may be obtained, free of charge, at www.investecassetmanagement.com. The Manager, PO Box 1655, Cape Town, 8000, Tel: 0860 500 100. Investec Asset Management (Pty) Ltd (Investec) is a member of the Association for Savings and Investment SA (ASISA). The scheme trustee is FirstRand Bank Limited, PO Box 7713, Johannesburg, 2000, Tel: (011) 282 1808. All information provided is product related, and is not intended to address the circumstances of any Financial Service Provider’s (FSP) clients. In terms of the Financial Advisory and Intermediary Services Act, FSPs should not provide advice to investors without appropriate risk analysis and after a thorough examination of a particular client’s financial situation. Investec Asset Management (Pty) Limited is an authorised financial services provider.