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Warning: You could be overpaying your fund manager for little or no returns

by , 08 July 2016
Warning: You could be overpaying your fund manager for little or no returns
It's a global argument that continues to gain traction and plague most fund managers. Crucially, today this argument is becoming more prevalent in the South African financial industry.

I'm talking about performance fees.

Should they be removed? Are investors getting their money's worth when investing in a fund?

There's a growing consensus that performance fees only benefit the fund manager, not the investor. And this has become one of the biggest concerns for investors, especially considering South Africa is experiencing a low return environment.

The fact is, you could be one of many investors who are paying fund managers unjustifiable amounts of fees for low IF any decent returns.

Let me explain…
 
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Performance fees: Just another way to take money from investors
  
The table below shows the current performance fees using five South African unit trust categories. 
 
 
 
There are two important things I want you to note:
 
  • If you look at the column, “Average TER of funds charging performance fees”, you’ll see that these funds are more expensive than those that don’t charge performance fees. Simply, you’re not only paying a higher management fee, you’re also paying a performance on top of that.
But here’s the most ludicrous part…
  • If you look at the one year returns for both, funds that do and don’t charge performance fees, you’ll see that the funds that DO charge performance rarely beat the funds that don’t.
My point is, looking at the table above, performance fees are certainly not justifiable and in no way benefits the investor. 
 
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What can you do to make sure you’re not paying more for less reward?
 
As a general rule:
 
#1: Don’t buy funds that offer a performance fee on top of a base fee.
 
Why?
 
This way, the fund manager will never lose, even if he underperforms. He’ll still get the base fee. If the fund does perform, the fund manager will earn more, because of the performance fee.
 
#2: Make sure the benchmark matches your risk and expected performance
 
If you invest in a fund that only invests in equities, then make sure it’s ONLY tracking an equity index, not another asset.
 
Tracking another index such as cash (on top of equity) could dilute your expected returns, as equities generally have higher returns than cash.
 
#3: Don’t buy funds that still charge performance fees, even if they consistently underperform
 
This is pretty straight forward. You’re practically giving away your money to some fat cat fund manager, while he makes you nothing or even loses you money.
 
For example: “If a fund uses the FTSE/JSE All Share Index as its benchmark and the index falls 20%, the fund will still have beaten the benchmark and can still charge performance fees if it only falls 19%.” - MoneyWeb
 
 
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A slow win for South African investors
 
Last year, Old Mutual and Coronation removed the performance fees from a number of their funds.
 
But as more funds come under serious scrutiny, hopefully the removing of performance fees as a whole is just gaining momentum.
 
More importantly, as investors, you need to be aware of what you’re paying for and thoroughly analysing if paying a performance is justifiable…Which I don’t think it is!
 
Until next time,

Knowledge brings you wealth,
 

Joshua Benton,
Editor, Real Wealth



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