This article was first published in the 4th quarter 2017 edition of Personal Finance Magazine
Keeping fees to a minimum is a priority for investors, particularly in a low-return environment. Many investors are turning to passive, or index-tracking, investments because these products have lower fees than those of actively managed products. Index-tracking unit trust funds and exchange traded funds (ETFs) are two main ways for investors to access investments that track an index.
Both ETFs (except commodity ETFs) and unit trusts are collective investment schemes regulated by the Financial Services Board (FSB) and contain mechanisms that protect investors’ assets if a product provider goes bankrupt. Both index-tracking unit trusts and ETFs aim to replicate the performance of an index. Despite these similarities, ETFs are akin to shares listed on a stock exchange and have a different risk profile to unit trusts.
This article is not about whether index-tracking unit trusts or ETFs are more cost-effective. It aims is inform you of all the costs you should take into account when investing in ETFs. These can be broken down into product costs, access costs, and the bid-offer spread.
Product costs Product costs are disclosed on the fund fact sheets published by product providers. On these fact sheets, you will find the management fee, the total expense ratio (TER) and the transaction cost.
The TER is an international standard used to measure the impact of management and operating costs on a fund’s value. In other words, it provides you with an indication of how these costs affect the growth of your investment. Expressed as a percentage, a fund’s TER is calculated by dividing the portfolio costs by the market value of the fund. The fund’s market value (total assets) is the daily average value of the portfolio over a specific period. A fund’s TER is calculated over a rolling 12-month period (or since the inception of the fund) and annualised to the most recent quarter-end.
An ETF’s TER includes the following:
Asset management fees;
Taxes (for example, VAT);
Custodian and trustee fees (custodians and trustees are appointed to protect the interests of investors); and
JSE listing licence fees.
The transaction cost is the cost incurred in the buying and selling of the fund’s underlying assets. It is calculated over a year and expressed as a percentage of the fund’s net asset value (NAV), which is the total value of the assets in the portfolio at a specific time, plus net accrued income (income less expenses), divided by the number of shares outstanding. The NAV is net of the TER.
The total investment cost of a fund is the sum of its TER and transaction cost. Fund returns are reported net of the total investment cost, so you should not subtract the total investment cost from the return to work out the growth on an investment.
There are two potential costs that are excluded from the total investment cost:
An initial fund fee, which is deducted from the investment amount. Most unit trusts have done away with initial fees, and the ETFs included in this survey do not have initial fees.
An initial and annual advice fee, which will apply if you invest through a financial adviser. The fee would be negotiated between you and your financial adviser.
As Table 1 shows, most product providers charge a set, percentage-based management fee, which is usually the largest component of the TER. There are two exceptions:
1. Ashburton bases the management fee for its MidCap and Inflation ETFs on how much you invest. In the case of the MidCap ETF, the fee is 0.5 percent for amounts up to R20 million and 0.2 percent on higher amounts. With the Inflation ETF, the fee is 0.36 percent up to R30 million and 0.15 percent thereafter. The fees exclude VAT. Ashburton says it charges a low set fee of 0.1 percent on the Top 40 ETF because this fund is popular and widely traded. The MidCap and Inflation ETFs are more specialised in nature, and the sliding fee structure is designed to make it attractive for institutional investors to invest large sums.
2. Sygnia took over the db X-trackers from Deutsche Bank on July 1. In September, these funds were renamed as Sygnia Itrix ETFs. The annual management fee is based on two variables: how much you invest and whether you continue to invest through the db X-trackers investment plan or transfer your ETFs to Sygnia’s Alchemy investment platform. If you invest in the MSCI World ETF through the investment plan, the fee is 0.6 percent on an investment up to R100 million, and 0.4 percent on higher amounts.
If you transfer your investment to the Alchemy platform, these management fees are reduced by 0.1 percentage point. If you invest in the DJ Eurostoxx 50, FTSE 100, MSCI Japan and MSCI USA ETFs via the investment plan, the fees are 0.75 percent on an investment up to R10 million, 0.6 percent on an investment above R10 million and up to R100 million, and 0.4 percent on higher amounts.
If you invest in these funds via the Alchemy platform, the fees are 0.55 percent up to R2 million, 0.5 percent for an investment above R2 million and up to R100 million, and 0.3 percent for an investment above R100 million. (The fees exclude VAT.)
These TER reductions are not done inside the ETF because an ETF cannot have more than one fee class. The reduction in the TER based on the size of the investment or the platform used is effectively done as a rebate outside the fund.
When comparing the costs of different ETFs, or the costs of ETFs with index-tracking unit trust funds, investors can make the mistake of looking no further than the total investment cost. But because ETFs are listed securities, they must be bought and sold through a stockbroker, and investors must pay brokerage on each transaction.
Investors can trade ETFs in three ways:
1. Through a stockbroker registered with the JSE. Go to www.jse.co.za > Membership > Find a broker for a list of stockbrokers. Some stockbrokers enable you to open an online account.
2. Through a product provider’s investment platform. Some ETF providers have online investment platforms that enable you to invest in and trade their funds. They may also offer an investment plan so that you can make recurring investments. These providers have entered into arrangements with stockbrokers, who execute the trades.
3. Through a third-party investment platform, which is similar to the investment platforms offered by product providers, except that third-party platforms allow you to invest in and trade the ETFs of a number of different product providers.
Table 2 shows the costs of investing through an ETF product provider. If you use an ETF provider’s platform, you can invest only in the provider’s products. The exception is Sygnia, which has its own funds and has an investment platform that enables you to trade in the funds offered by other providers. The db X-trackers are now Sygnia (internal) funds, and this table excludes the impact on costs if you invest in external funds, or both internal funds and external funds, on the Alchemy platform.
Table 3 shows the costs of investing through three third-party investment platforms designed for investors in ETFs/index-tracking funds:
1. etfSA, which enables you to invest in all (some 80) the exchange traded products (ETFs and exchange traded notes) available in South Africa. It also offers four tax-free savings accounts consisting of pre-selected ETFs, or you can choose which ETFs you want to include in a tax-free account, and three retirement annuity (RA) portfolios and four living annuity portfolios with ETFs as the underlying investments.
2. Itransact, which enables you to invest in all the available exchange traded products, as well as 10 investment and RA portfolios comprising baskets of pre-selected risk-adjusted ETFs.
3. Sygnia Alchemy, which offers access to 51 exchange traded products.
To give you an idea of the costs if you choose an alternative channel, Table 3 also shows the costs if you invest through EasyEquities, an online platform for investing in listed securities, and two online stockbrokers chosen at random, Sanlam iTrade and PSG Online.
The administration fees and brokerage exclude certain mandatory and statutory charges, namely the Investor Protection Levy and the Strate settlement fee. ETFs and tax-free savings accounts are exempt from securities transfer tax, which is charged at 0.25 percent of the value of the shares traded.
Both stockbrokers and investment platforms charge administration fees and stockbroking commission. However, there two advantages to using an investment platform if you are a small investor. First, stockbrokers charge a minimum commission per trade, which can make the cost of small trades, such as reinvesting dividends, very expensive.
Second, with a stockbroker, each transaction – such as selling one ETF and buying another – is counted as a separate trade and full fees are charged on each trade. Investment platforms can “bulk” the trading costs by using administrators registered with the FSB as Category Three financial services providers, which are authorised to do such bulking. Because the commission and mandatory or statutory charges are bulked among all the investors trading on a particular day, the trading costs are substantially reduced. There are also no minimum charges per trade.
The costs in Table 3 apply if you invest directly in ETFs. If you invest via an RA fund, preservation fund or living annuity, you usually have to invest via a linked-investment services provider and pay an administration fee.
The costs disclosed by product providers, stockbrokers and investment platforms are not the only costs associated with ETFs (or unit trusts, for that matter). Investors also have to take what is known as the bid-offer spread into account. The bid-offer spread is the difference between the price a buyer is willing to pay for a security (bid price) and the price that a seller is willing to accept for a security (offer price). All securities, whether listed or unlisted, are subject to bid-offer spreads.
As stated above, an ETF has a NAV; however, the market price of an ETF – the actual price at you buy or sell an ETF – may differ from the NAV, depending on the bid-offer spread. An ETF can trade at a premium (market price is higher) or discount (market price is lower) to its NAV. The bid-offer spread captures the inefficiencies of supply and demand in the market and the profit taken by “market makers”.
For ETFs to be traded, there must be someone who wants to bid on an ETF that someone else wants to sell, and vice versa. If there aren’t buyers when you want to sell, or sellers when you want to buy, the market lacks liquidity. To solve this, ETF providers appoint brokerages to “make the market” – they guarantee to buy ETFs from investors when there are no sellers. Market makers charge fees for this service.
The bid-offer spread can only be known at the time of each ETF trade.
As stated earlier, this article is not a comparison of unit trust and ETF costs. However, it should be pointed out that there is a misconception that ETFs are affected by the cost of bid-offer spreads, whereas unit trusts are not. There is much debate over the extent to which spreads ultimately impact the costs of these two types of investments.
What about the effective annual cost?
In 2016, the Association for Savings & Investment SA (Asisa) announced the introduction of a cost comparison standard called the effective annual cost (EAC). The purpose of the EAC is to enable investors to compare costs across different products, such as unit trusts, ETFs, living annuities, RAs and endowment policies.
The EAC standard requires product providers to disclose four separate components of charges (including VAT) and calculate the EAC assuming that an investor terminates the investment at the end of specific periods. The four cost components are:
Investment management charges;
Advice charges – initial and annual;
Administration charges; and
Other charges, such as termination charges, penalties, loyalty bonuses, guarantees, smoothing or risk benefits, wrap fund charges and risk benefits.
The EAC must be calculated separately for each of the four components and totalled to produce on EAC figure for the financial product, expressed as a percentage. All charges that an investor will incur must be included in the EAC measure. When a charge is not available, a reasonable best estimate must be used.
The requirement to disclose the EAC is being phased in, and all products should be compliant by June 1, 2019.
The different cost components associated with the channels through which investors can access ETFs make it difficult to provide an EAC upfront. The EAC depends on the costs specific to that channel, whether or not it includes a fee for financial advice, and whether the investment is a lump sum or recurring.
Absa’s fact sheets disclose the EAC, which includes the fund TER and fund trading cost, on a quarterly basis. They refer to the EAC as a measure of the charges that an investor will likely incur by investing in ETFs. However, Absa’s EAC calculations do not include platform administration or advice fees, because these are normally charged by an investment platform chosen by the investors.
Itransact’s website has a “Fee calculator” that enables you to calculate the EAC for the products on the platform. You must enter the investment amount (lump sum or recurring) and the financial advice fee (if any). The calculator provides a breakdown of the four Asisa-required cost components and the EAC assuming terms to maturity of one year, and three, five and 10 years.
The Satrix website has a calculator that enables you to calculate the EAC of each fund, depending on whether you invest via the investment plan or SatrixNOW. This calculator also takes the Asisa-required cost components into account, and the EAC assumes various terms to maturity.
SOME THINGS TO CONSIDER
You need to decide whether you intend to confine yourself to the ETFs offered by a specific provider or invest in the funds offered by different providers. If the latter, you need to compare the costs of stockbrokers or investment platforms that allow you access a variety of funds.
When it comes to choosing between a stockbroker and an investment platform, a crucial consideration is how much you have invested and the size of the trades. For small investors, an investment platform is usually the better option, but once you have investments of about R10 million, or trades of between R50 000 and R100 000, a stockbroker is more cost-effective.
This is because the fee a broker charges to hold your investment and the minimum trading fee are a small percentage of your portfolio or trade. But stockbroking charges can consume a large percentage of your investment if you are investing relatively small amounts. You may choose to start on an investment platform, but as your investment builds up, you should assess whether it may be more cost-effective to switch to a stockbroker.
Investment platforms execute their trades once a day, whereas stockbrokers trade throughout the day. A stockbroking platform allows you to respond instantly to movements in the market that could affect the value of your investment. If you’re a high-net-worth investor, even relatively small moves can have a significant impact your portfolio.
A stockbroking platform allows you to monitor the bid-offer spreads of securities in real time, and you can choose to trade when the spread low. If you trade very large amounts through a personal stockbroker, your broker can negotiate a lower spread with the market maker.
Administration fees are usually based on the value of the portfolio, whereas brokerage is charged per trade. If you intend to buy and sell frequently, paying the lowest brokerage will be more important than is the case if you are committed to investing in a product, or products, over the long term. Remember, however, that even if you aren’t buying and selling ETFs, you will pay brokerage when your dividends are reinvested to buy more shares, or to buy more shares if you have a debit order.
Where an administration fee is based on the value of your portfolio, the more you have invested, the lower the fee. Find out whether the administration fee takes into account the value of any other investments, such as unit trust funds and RAs, you access via the same platform. If it does, your administration fee could be reduced significantly.
When comparing access costs, those “zero-point-something” administration and brokerage fees can seem negligible, but you may be unpleasantly surprised by how these percentages end up affecting your returns. You will get a more realistic idea of the impact of access fees by calculating how these percentages translate into rand amounts, based on how much you intend to invest.
Some platforms charge a fee for processing debit orders, and you will certainly be charged a fee if a platform’s attempt to process your debit order is rejected.
Tax is another type of cost that eats away at your returns. Some investment platforms enable you to invest in ETFs through tax-free savings accounts, which means you save on dividends tax, tax on interest income and capital gains tax (CGT). Also, find out whether the administration and other fees are discounted on a tax-free option.
You can transfer your ETFs from one platform to another without incurring CGT (provided both accounts are held in your name). However, you need to check whether the platform you intend to leave will charge a transfer or exit fee.