By Tim Hewson
15 February 2008
As global financial markets continue to show signs of significant instability, the question of how much it costs the confident investor to invest in managed funds begins to take on an even greater importance.
Since you will pay fees in one form or another, regardless of whether the managed fund makes money, and since the fees payable can vary significantly, it's important you know how much it could end up costing you.
Within the wealth management industry, FEES is a dirty, four-letter word and an issue constantly under the spotlight. Most notable is the issue of who pays what to whom, when and what for.
The principal issue is transparency, and as far as the confident investor is concerned the more transparency the better.
FEES….Forget Everything Everyone Says - Do your research!
According to the law which the Australian Securities and Investments Commission (ASIC) administers, fund managers are required to clearly disclose all fees payable in the Product Disclosure Statement (PDS) for each fund.
In an attempt to improve transparency, ASIC has moved to clean up the jargon used to explain chargeable fees.
Similarly, the Investment and Financial Services Association (IFSA) have set clear rules relating to fee calculation methodologies, which will ensure consistency across all funds.
This way an investor will get a clear picture of the comparable cost of investing in one fund over another, and can rely on standardised examples to explain the annual percentage and dollar costs of managed fund investing.
Wholesale vs Retail
Of course, not all funds are the same. The most noticeable difference is in the fees charged by wholesale and retail funds.
For example, an investor accessing a wholesale fund might pay an annual fee of 1.00%p.a., compared to a retail investor who may pay up to 3.00%p.a. to access a comparable investment strategy.
A wholesale fund is principally designed to cater for investors who have more than $100,000 to invest in a fund. In comparison, a retail fund is generally designed for investors with smaller amounts of $1,000 to invest. However, it is possible for investors with $1,000 (or less) to invest in a wholesale fund, you just need to do your research.
Fees, fees and more fees
The following provides an overview of the types of fees a fund manager may charge an investor who invests directly in a fund:
Establishment Fee: charged by the fund manager for setting up your account in the fund. May be set as a percentage of your original investment, but is generally a fixed dollar amount.
Withdrawal Fee: (Exit Fee): charged by the fund manager for every withdrawal from the fund. May be a percentage or a flat fee.
Termination Fee: charged by the fund manager when you close your account in the fund. May be a percentage but is generally a fixed amount.
Ongoing Fee: (Administration/Management Fee): charged by the fund manager to cover the cost of management administration and any reimbursable expenses incurred.
Fees vary depending on the fund type, but generally range from 0.40%p.a. for wholesale and up to 3.00%p.a. for retail funds. Most often deducted from the fund's asset earnings and reflected in the unit price and fund performance.
Switching Fee: charged by the fund manger for switching (changing) your investment between funds. Generally charged as a flat fee.
Performance Fee: charged by the fund manager for outperforming a prescribed benchmark. Fees generally vary, but are either 10 or 20 percent of the out-performance and are deducted from the fund performance and reflected in the unit price.
Note: funds that charge a Performance Fee generally have a marginally higher Management Fee.
Buy/Sell Spread: charged by some fund managers to cover administration costs and/or the need to buy/or sell units in the fund to absorb the cost of buying/selling investments and to avoid the costs being absorbed by other investors.
Spreads may vary, but generally range between 0.10% - 0.60% and are reflected in the margin between the respective buy (entry) and sell (exit) unit prices.
Advice: But at what cost?
If you invest in managed funds indirectly via a financial planner, you are also likely to pay some or all of the following:
Contribution Fee: (Entry Fee): charged by a financial adviser for each investment made into the fund. May be as much as five percent, which would leave you with a net investment of only 95 percent of your original investment amount.
Adviser Service Fee: charged by the adviser. May include commissions paid to the adviser by the fund manager for selling or distributing their fund. Commissions paid to the adviser typically range from 0.25%p.a. up to 0.88%p.a. and are generally paid on a monthly or quarterly basis.
Note: the Adviser Service Fee is different to the Investment Advice Fee, which is payable if you engage an adviser to provide you with investment guidance. Can be negotiable and it's worth ensuring you are comfortable with the finalised structure.
Platform Fee: An administration fee charged for the consolidation of your investments onto a single platform. Fee tiering will vary depending on the total value of your portfolio and the funds you invest in. Generally in the range of 1%p.a. and paid directly to the platform.
Other industry fee measures you might find useful when comparing options include:
Management Expense Ratio (MER): measures the total costs of operating a fund as a percentage of average total assets, usually expressed as an annual percentage.
MER is typically the best measure used by direct investors when quantifying the fees payable for a particular fund.
Indirect Cost Ratio (ICR): represents the ratio of the fund's management costs relative to the value of your investment. ICR accounts for all fees and expenses not deducted directly from an investors holding, but to a fund's total average net assets.
Ongoing Fee Measure (OGFM): provides potential investors with a measure for comparing investment options. Also provides additional disclosure periods, which are not indicative of the future and where fees or expenses may have been waived.
Whilst navigating through the fee maze, it's vital you know what fees are paid to whom and when they are deducted. Most importantly, how much it will cost you.
Saving on fees is simple
Assuming you have a clear investment objective and it's proportionate with the fund/s you have selected, keep these five simple tips in mind when evaluating the costs of managed funds investing:
1. Wholesale funds generally provide better value and can be accessed by retail investors.
2. Look for funds without Establishment, Contribution, Withdrawal and Termination Fees.
3. Ongoing fees like Management and Administration fees are unavoidable. So, make sure you are comfortable with the fund manager selected, compare Management Fees, MERs and seek administrative excellence.
4. If you are a DIY investor, you can save on fees paid to an adviser by investing directly in wholesale funds.
5. Check out ASIC's fee comparison calculator on their Fido website and the IFSA Standards for Fee calculation methodology.