Those who trust the equity market to grow their wealth over time are in for a shock when they see the true impact of fees on their nest-egg.Investors who think one or two percent in fees does not make much difference are deluding themselves.
The alert over value-depleting fees comes from Deutsche Securities, a South African leader in the field of cost-efficient passive investment and exchange traded funds (ETFs), a listed instrument that tracks a specific index.
The company demonstrated the point by studying net returns achieved by the JSE’s All Share Index (Alsi) over the 20 years to May 2009, and says the pattern of value depletion holds true for all investments where fees are charged as a percentage of assets under management.
The study showed that if you invested R100 in an Alsi portfolio through a company that charged ongoing fees of 2% a year (2.28% VAT inclusive), your R100 would today be worth R727.31.
If you paid no fees at all, your investment would have grown to R1,152.39.
This is 58% more than an investment depleted by fees of 2% plus VAT per year. That’s significant erosion. It might be the difference between retiring in comfort or retiring with insufficient funds to maintain a decent lifestyle. If you were charged 1% fees per annum plus VAT the difference on the optimum market-generated return would be 26%. When scrutinising fees, retail investors should guard against thinking that another one or two percent is not very much. Your mindset is totally different once you realise that the fee structure could cost you half or a quarter of total potential returns over time.
Traditionally, the South African investment industry has been heavily tilted toward fee-rich active fund management, whereby fund managers try to outperform the market in a quest for so-called alpha.
The less expensive alternative for long-term saver-investors is passive investment based on instruments that mirror the market and deliver returns in line with the chosen index.
Most ordinary investors who commit to long-term equity-based saving believe they are buying the market and perhaps a bit of alpha promised by the active managers while banking on equity’s history to out-perform other asset classes over time.
This is only partially true. History is on your side all right, but you are buying what’s left of market growth after fees have been deducted. If you want to buy the market – an extremely sound concept – then it makes more sense to buy into products that track the market at low cost.
This proposition has turned passive, market-tracking investment through ETFs into a global phenomenon. The trend is only beginning to affect South Africa, but once the real cost of high fees is more widely known we expect much higher demand. History not only shows that equities are the best performing asset class, it also indicates that active management on average cannot outperform the market for any length of time.
On average, index-tracking funds beat the performance achieved by actively managed funds – which is one of the reasons why an investment guru like Warren Buffet endorses market-tracking products for the average retail investor.
Everyone tells you that you can’t time the market. Something that’s equally true, but said less often, is that you are unlikely to beat the market, either. You don’t need to because given enough time the equity market always delivers the goods.