Reducing the total cost of investment

As financial advisors gear up for the introduction of the Retail Distribution Review (RDR), the hope is that regulatory change will reduce conflicts of interests and frame costs in a different light.

Despite an ever-increasing focus on fees, the average South African investor arguably still doesn’t truly get bang for their buck.

Addressing financial advisors at the Alexander Forbes Investments IFA Symposium, Phil Young, managing partner of UK consultancy Zero, said investment costs and value have become global themes.

In the US and the UK, there has been pressure to reduce the total cost of investing to 2% (or less). This includes the advisor, discretionary fund manager (DFM), platform and fund manager fees.

While the South African investment market was smaller by comparison, and higher rates of inflation and interest made a direct comparison to these markets difficult, the debate and discussion around costs and value was unavoidable, Young said.

“The disrupters in this market are global businesses as well, so they would be bringing their thoughts and ideas to South Africa in just the same way as in the UK and in the US.”

Despite fears that the introduction of RDR in the UK in 2013 would spell disaster for the financial advice market, advisors are earning more money than ever before. It was tough for new advisors to get off the ground in the absence of significant commissions, but the typical advisor in the UK has an average of 150 clients, Young said.

“Advisors are earning more than ever before but there is an awful lot of talk about how the total cost of investment needs to come down.”

Yet, stakeholders differed about what the average total cost of investment in the UK was. Insiders put it at anything between 1.8% (plus hidden costs) to up to 4%.

Typically, however, the total cost of investing is around 2.4% or 240 basis points (see graphic representation below).

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In South Africa, the typical advisor fee is arguably closer to 0.75% (75 basis points), while the fund manager and platform fees are generally higher.

“There isn’t the same kind of scale out here [in South Africa] so I appreciate that you are always going to have a slightly different challenge to get those costs down.”

A lot of UK advisors have managed to get the costs down to 2% or lower, Young said.

How they did it

The majority of advisors run in-house model portfolios for some clients and are not using a DFM, thereby reducing the cost by 30 basis points (0.3%). Over the course of the past five years, around 5% to 10% of advisors have gone down a pure passive route and have reduced fund manager fees significantly as a result.

But most advisors have tweaked the model, and have used a blend of active and passive portfolios.

“[Using] a blend of active and passive where people are moving portfolios in-house gets it down to 185 basis points.”

This leaves some wiggle room to reintroduce a DFM if necessary.

But what about the end-investor? What about removing the advisor from the value chain?

Robo-advice was a big theme in both the US and the UK, but the cost of acquisition to build scale was high.

“A hundred-and-seventy-five basis points for no advice whatsoever doesn’t represent great value at all,” Young said.

As a result, most robo-advisors have headed straight for passive investments to get the costs down, reducing the total investment cost to around 120 basis points.

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But what has really caused a stir in the UK is Vanguard’s business model, where investors can access funds online for 20 basis points and a platform fee of 10 basis points.

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Young said in the UK, Vanguard had almost become the benchmark and advisory and DFM businesses increasingly have to demonstrate what value they could add to investors above and beyond Vanguard.

“It is putting robos under an enormous amount of pressure.”

The SA situation

Leon Greyling, managing director of Alexander Forbes Investments, said there had been a fair amount of compression across all parts of the fee value chain.

“That is not to say that it can’t go further and that it shouldn’t go further, but I think there is also a balance that needs to be found in that regard.”

Choosing a cheaper option did not necessarily mean that investors would meet their goals, he said.

While the fee debate is important, other levers should not be ignored – for example how much money investors are saving or if they were preserving their retirement benefits, he added.

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