Fees and investor's returns

One of the most significant factors that affect an investor’s return is the level of fees charged to either trade in securities or for the privilege of continuing to hold money in a collective investment scheme or mutual fund. Trading costs typically start at 1.5 per cent of the value of the transaction and, depending on the size of the trade, slide downwards to about 1.0 per cent of the traded value; in many cases, very large transactions can be negotiated and executed with a broker at lower fees. In the context of encouraging greater individual participation in the stock market, brokers could experiment with using standard dollar figures for different transaction ranges. In addition to encouraging new market participants, it might also improve their earnings as the market broadens. Using an arbitrary figure of $10,000, the minimum transaction fee could be set at $50, or 0.5 per cent of the transaction value. If the transaction is valued at say $5,000, this $50 fee would represent one per cent of the value or one-third less than the prevailing brokerage fee of 1.5 per cent. Perhaps, another effect of a fixed-dollar figure would be to encourage higher value transaction and more frequent trading. Investors who participate on the international markets are well aware that, even for small investors, fees can be quite competitive. 

 

 

Lauding mutual funds

Given that most local investors place the bulk of their savings in mutual funds, it is instructive to note that these schemes levy a variety of charges on investors that, in effect, pauperise them. Over a long period of time, even a 1.0 per cent annual fee reduces an investor’s returns quite significantly. For example, an investor earning 3.0 per cent annually on $100,000 for five years would have a nest egg of $115,927.41; in contrast, the same investor earning 4.0 per cent would have $121,665.29 at the end of the same investment period. The concept and general uses of mutual funds are very laudable, rational and widely publicised. Regular deductions, access to professional advisers and ability to use a portion of the sums owned to secure a loan are some of the commonly cited advantages. The latter example is also a feature of share investments that are directly owned by an investor. Where the hapless consumer can get pummelled is in the range and level of fees that are levied by the fund managers and sponsors.  For illustrative purposes, we will consider Unit Trust Corporation’s Growth and Income Fund, ANSA Merchant Bank’s Structured Investment Fund and RBC Caribbean’s Income and Growth Fund. According to the prospectus of the UTC, it is allowed to charge a management fee of 2.0 per cent of the assets under management and an “initial fee”—presumably for marketing purposes—of 5.0 per cent. To its credit, the actual management fee that was charged for 2010 was 1.7 per cent; hopefully, this downward trend would continue.  It is also encouraging that the spread between the bid and asked prices for this fund has narrowed from a very onerous 5.0 per cent to a more competitive 2.0 per cent. No doubt, this reduction was in response to competitive pressures.

 

 

Range of fees

The fees charged by ANSA Merchant Bank for its TT$ Structured Investment Fund are detailed more comprehensively in its prospectus. For starters, they have a 0.20 per cent as a trustee’s fee, subject to a minimum charge of $10,000.00 per annum. Next, there is an investment manager’s fee of 2.5 per cent annually. The fund administrator may also charge 2.0 per cent for his services and finally, there is a distribution charge of 1.0 per cent. In aggregate, a potential hurdle of 5.7 per cent, plus operating and transactional expenses, has to be crossed before any return may be paid to the investor. To its credit, this fund has often met and even exceeded its publicly-stated investment targets. There is a relatively high minimum investment of $50,000 for this fund. Probably due to its consistent successes, it is temporarily closed to new inflows from investors.

 

 

In the case of RBC Caribbean’s Income and Growth Fund, there is a maximum 2.0 per cent fee that is expected to cover trustee and management fees. As usual, the fee is based on average total assets of the fund. In its latest report to December 2011, the fund stated that its fees were 2.29 per cent for 2010. (This appears to be a breach that should be corrected in a subsequent period.) In all these examples, various fee arrangements emphasise that payments are to be based on the average total assets of the particular fund. It seems quite possible that a fund may lose money, yet these various assortments of fees can be dutifully paid. In essence, profitability considerations, which are the prime concern for investors, seem to be of secondary importance. As an aside, investors, realising a good thing when they see it, make ample use of income funds. Even with onerous fees, the returns on these funds are still preferable to abysmal payments made on bank saving or term deposits, where they are still offered. An alternative approach to the calculation of fees could be based more directly on the fund’s profitability. 

 

 

Fine-tuning fee formula

In this arrangement, for example, a fund earns say $1 million, broken down as 30 per cent in unrealised capital appreciation and 40 per cent from realised capital gains and 30 per cent from dividends and interest receipts. Perhaps, as much as 25 per cent of this gain can be shared with the trustee, manager and custodian while the remainder can be reinvested or returned to the investors as appropriate. Naturally, this formula would have to be fine-tuned to assure that the fee-takers receive a certain minimum annual payment, based on their services and on the fund’s asset size. As outlined above, this concept tries to place the fund sponsors and investors on the same side of the investment table. As presently configured, fund sponsors, trustees, investment managers and others always get paid and have the first pick of the juicy mango, so to speak. Investors, on the other hand, may or may not benefit to the same extent and often are left with the short end of the stick. While one appreciates that investing always carries a certain level of risk, it would be a refreshing change if the sponsors and allied professionals of funds share some of this risk and, of course, enjoy some of the rewards and heartaches that investors face daily. Perhaps, this co-operative compensation arrangement could be incorporated into the draft mutual funds legislation, which seems to be taking a very long time to see the light of day.