Impact of escalating regulatory costs on fund managers


By Eldria Fraser (Chief Investment Officer)


EldriaAlthough fund management is a growth industry internationally, in South Africa an onerous regulatory burden is contributing significantly to rising costs and squeezed margins.

According to Eldria Fraser, Chief Investment Officer at Prescient Investment Management, “Fund managers always have an eye on costs but these have become harder to control with increased regulation, compliance and reporting requiring more systems, software and staff.”

“That’s not going to change in the near future and fund managers, reliant on trust and confidence, will need to ensure that their businesses remain robust to ensure performance is maintained and the risks of compliance breaches are mitigated.”

Fund management fees are under scrutiny as the National Treasury looks to broaden the savings base, improve preservation and reduce the costs of saving, which are regarded as important because they impact the end result.

“That it is now compulsory to publish a total expense ratio (TER) on fund factsheets, which encapsulates management fees and costs, has also placed the focus on fees,” says Ms Fraser. “However, a point often missed is that the asset management fee is only part of the overall cost of saving.”

A pension fund, for example, can pay a negotiated asset management fee based on institutional bulk rates. But the fund will also need to pay an asset consultant, actuary or employee benefits consultant and administrator – resulting in multiple layers of fees and costs, all of which need to be looked at.

Ms Fraser says that when it comes to pricing, South African fund managers are competitive at both the retail and institutional levels when compared with international norms.

This applies especially to equity and balanced funds. With bond mandates, some local fees are higher than those charged internationally where the ultra-large global index bond managers, because of their size, can charge unusually low fees.

“What clients pay in terms of fees depends largely on whether they’re buying passive or active investment management services. Those paying 3% or more are likely to be invested in an active fund where the fee is a consequence of a performance component.

“Many institutional clients prefer combined strategies that utilise lower cost passive or smart beta products with others that target active out-performance. This core-satellite approach can work well by maintaining costs while also building in a component to deliver out-performance,” she says.

Managers negotiate fees either on a sliding scale basis with no performance element, or as a base fee plus a performance fee.

Says Ms Fraser: “Performance fees have received a lot of bad press, but can work well for both the investor and the manager. Investors should consider which is appropriate for them.  One of the things to keep in mind when evaluating a performance fee is that the base fee should be lower that the opposing sliding scale fee offered. This ensures that the manager is giving up on the ongoing fee in favour of an added performance fee when doing well.

The performance participation rate must be reasonable with the market norm to share between 10% and 15% of outperformance. The performance element must be linked to an appropriate benchmark and hurdle. Whether a composite index plus hurdle or inflation-linked hurdle, the benchmark must fit the mandate.  It is also good to consider a cap on the total level of performance fee paid.”

“After that, it’s a case of measuring the fund manager against the hurdle. In this regard, investors appointing managers will look for longer term consistency in an effort to avoid chopping and changing because of the costs involved.”

Although there has not been a big reduction in the fees charged by traditional asset managers, new cost-effective products like index funds have been introduced to the market. With retirement reform underway, these products have an important role and ETFs in particular have grown strongly internationally, while in SA the growth has largely been limited to commodity and offshore ETFs.

However, it’s important to look carefully at what you’re paying for; ETFs as the management fee or TER may not be the full cost of investing.  If you buy the ETF on the market, take note of the difference between the bid and sell price and also check if there is an additional brokerage fee or entry charge.

This all affects the actual return you achieve when buying the product, which is not reflected in the NAV performance.  It can often be cheaper for a larger client to buy an index unit trust or negotiate a segregated account with a fund manager rather than buying an off the shelf ETF.

In terms of building asset volumes, Ms Fraser notes that the distribution of investment products in the institutional market is set to change as part of the reform of the retirement industry. Stand-alone pension funds will be encouraged to become part of umbrella platforms where fund managers will need to be represented with the right products backed up by performance.

About Prescient Limited

  • Prescient’s subsidiaries include: Prescient Investment Management (SA), Prescient Securities, Prescient Management Company, Prescient Life, Prescient Fund Services, Prescient Wealth Management, Prescient Profile, Prescient Property Investment Management and EMH Prescient Investment Management.
  • Prescient Investment Management was named Overall Investments/Asset Manager of the Year at the Imbasa Yegolide Awards 2011 and Absolute Return Manager of the Year in 2013.
  • Prescient has a Dublin registered fund management company, Stadia Fund Management, and a representative office in Shanghai, China.
  • Prescient Investment Management was the first institution in Africa to be granted a Qualified Foreign Institutional Investor (QFII) licence by the China Securities Regulatory Commission (CSRC).

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