Edition: Mar - May 2014


Unnerving case study

A reader has asked about the effect of charges on his retirement portfolio. Independent financial planner Dave Crawford has responded.

In this example I have used 45,99% invested in Allan Gray Equity, 37,69% in Coronation’s Top 20 and 16,32% in ABSA’s Balanced Fund. When weighted, this provides a total expense ratio (TER) of 2,12% including vat. When added to a 0,5% annual advice fee and 0,5% annual administration charge plus vat, it gives a total annual fee drag to growth of 3,26%.

But these days few advisors work on 0,5%. They more likely want 0,75% or 1% to which vat must be added. So the estimate by David McCarthy, in the National Treasury discussion paper, that fees are around 3% of capital is fair if sometimes conservative.

I have refined the calculations to show the percentage of nominal growth that the investor gets. It’s rather unnerving.

Many advisors justify the high charges on the basis that expensive is good quality. So they think the fuss about costs is a storm in a teacup. I fear they will still see their backsides on that one.

From a spreadsheet, I’ve have tabled here the numbers that I think are significant. Let’s assume that you invest R100 000 to run for 30 years. I have used a single investment return (before costs and TERs) of 14% per annum:

End yearGrowth @0% cost% accuring to investor at 1.5%pa cost% acccruing to investor at 3.26%pa cost
5R92 54186.67%71.91%
10R270 72283.01%65.52%
15R613 79479.05%58.97%
20R1 274 34974.90%52.53%
25R2 546 19270.70%46.40%
30R4 995 01666.55%40.72%

It’s amazing what a difference the costs make. On the next table, using a 10% gross return, retention by the investor gets relatively lower. The cost issue really looks as if it could be a significant contributor to the retirement crisis.

One reason costs aren’t taken as seriously as they should is that, in the selling process, small percentages are dismissed as immaterial. But clients either don’t understand the baseline effect or don’t give it credence. An annual cost of 3,26% on your capital is actually a yield reduction of 3,26% on the yield (income return on investment). So the 3,26% cost on a 10% yield is actually a 32,6% reduction in yield. Now that is serious.

If we perform the same 10% exercise on the gross return, the investor gets relatively less:

End yearGrowth @0% cost % accuring to investor at 1.5%pa cost % acccruing to investor at 3.26%pa cost
5R61 05182.50%63.17%
10R159 37479.12%%57.72%
15R317 72575.53%52.26%
20R572 75071.79%46.90%
25R983 47167.99%41.77%
30R1 644 94064.19%36.95%

Getting worse is the practice of using a wide spread of unit trusts to create a “portfolio”. I saw one a little while ago where 10 different unit trusts were packaged (or wrapped) together, probably to impress the client. I also saw one such package being assembled by an administration provider’s representative in the broker’s office with the client present.

The instruction was “Get me a nice portfolio for (client), I think about 35% equity and not more than 10 portfolio managers”. The rep clicked a few buttons on his iPad and hey, we had an investment portfolio. Effectively this is the “expertise” for which an advisor can get paid, and paid and paid.

McCarthy talked about this at the 10X Conference. Also, there’s a pertinent quote from the National Treasury paper on costs:

“Many consumers may choose to diversify their holdings across active asset managers, or be encouraged by their financial advisors to do so. While this approach does diversity the operational risks associated with individual fund managers, it may simply result in a very high-cost passive fund, since the greater the number of underlying asset managers, the more likely that their competing market views in the same asset class will offset one another....Further, some studies suggest that changing managers regularly, based on their past performance – ‘chasing winners’ – is also a strategy which may significantly reduce long-run returns.”