Sep 2, 2021
The introduction by the Association for Savings and Investment SA (ASISA) of the Total Investment Charge (TIC) as a measure that allows investors and advisors to assess the impact of all charges and expenses incurred in the management of unit trusts, has improved transparency and fee comparability. Importantly though, while the TIC is a relatively new disclosure requirement, the underlying charges and expenses have always been levied and therefore unit trust fund performance has always been after the impact of these charges and expenses.
Essentially, the Total Investment Charge is the sum of a fund’s Total Expense Ratio (TER), i.e. any expenses incurred in managing the fund – e.g. fixed (and performance, if applicable) management fees, administration costs, custody fees, trustee fees, audit fees, bank charges etc. – and the fund’s Transaction Costs (TC), i.e. the costs incurred in the buying and selling of the assets in which the fund invests (e.g. brokerage, VAT, Securities Transfer Tax, etc.).
While funds that charge the same annual management fee have similar TERs, their TCs can vary widely. This has raised some interesting questions relating to price paid versus value received.
Consider the TCs for the Ninety One Opportunity and Managed Funds, which are both balanced (multi-asset high equity) funds:
Does this mean that the Ninety One Opportunity Fund is a better investment solution for investors? The short answer is no; it is just different!
Portfolio managers apply different investment philosophies to managing money, be it Growth, Value, Earnings Revisions, Price Momentum or Quality. While Value and Growth are the more recognisable and better understood investment styles, each has its own unique approach to analysing and selecting assets. Importantly, each approach also impacts on how frequently or infrequently the portfolio manager buys and sells assets and thereby incurs transaction costs on behalf of the fund.
It is our view, therefore, that TCs be considered as part of the investment pillar decision, not the cost pillar. This is the approach taken by many UK fund selectors who recognise that portfolio managers should not be deselected because the way they manage money results in higher TCs, especially where the performance track record is attractive relative to lower TC solutions.
The Value and Quality investment styles are more ‘buy-and-hold’ in nature. Funds that are managed accordingly e.g. the Ninety One Value and Opportunity Funds respectively, tend to have low(er) turnover ratios (as low as 15–20% p.a. for Ninety One Opportunity) and hence lower TCs. On the other hand, Growth, Earnings Revisions and Price Momentum are all styles which tend to demonstrate an active trading approach, where actively changing the fund as and when market conditions (growth prospects, future earnings or trends) change, is a key contributor to long-term returns. Funds managed according to one of these styles tend to have above-average turnover ratios and therefore above-average TCs.
Importantly, there is no single route to investment success, and a higher or lower TC is not a determinant of long-term fund outperformance.
The following risk/return scatterplot (Figure 1) illustrates that over the long term investing using either an Earnings Revisions (Ninety One Managed) or a Quality (Ninety One Opportunity) philosophy would have delivered similar above-average returns. It is the return series path, i.e. how they get there that differs. Figure 2 shows how the different styles behave over time.
Figure 1: Risk versus return scatterplot: 1 January 2003 to 31 July 2021, being the common period that Gail Daniel and Clyde Rossouw managed the Ninety One Managed and Opportunity Funds respectively
Source: Morningstar as at 31.07.2021. Returns are calculated on a NAV-to-NAV basis, net of A-class fees, with gross income reinvested. Market indices are gross of fees. Highest and lowest 12 month rolling performance since inception is: Ninety One Opportunity = 43.8% and -15.7% respectively, and Ninety One Managed = 47.2% and -23% respectively.
Figure 2: Extreme market conditions give a sense of how different styles behave 2008 crash, 2009 recovery market inflection points
Source: Citi Research, Ninety One, Period = January 2007 to December 2009; Long-short style portfolios.
The results of Schroders' research, which challenges the myth that global portfolio turnover produces poorer outcomes for investors due to the additional costs it incurs, support our view articulated above.2
Schroders concludes: “Our analysis suggests that the presumption that turnover and transaction costs are to the detriment of investors is misguided as it fails to consider whether these costs lead to better or worse outcomes. We find that, on average, high turnover US equity managers have been able to add at least enough value to offset the additional transaction costs they are exposed to. There is no evidence of a significant relationship between turnover and excess returns. What is surprising is that this is true even in small caps where the costs of trading are noticeably higher.”
In conclusion, a lower TC does not imply nor result in a better investment outcome. It is essential that advisors and investors confirm that a fund delivers performance over time consistent with its investment mandate and the fund manager’s investment philosophy, remembering that the style directly impacts the fund's TC.
Given the importance of making the correct decision, we strongly recommend that investors seek professional investment advice, tailored to their individual circumstances.
1 Benjamin Graham, The Intelligent Investor, 1949.
2 Schroders, Churn is not necessarily burn: debunking the myths of portfolio turnover, July 2017.
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