‘Keep It Real’ - A Gryphon Op-Ed Series: Part 3 of 5
‘A meaning which fits the theme of "that's the way the money goes" involves pawning one's coat in desperation to buy food and drink, as "weasel (and stoat)" is more usually and traditionally Cockney rhyming slang for "Coat" rather than throat and "pop" is a slang word for pawn. Therefore, "Pop goes the weasel" meant pawning a coat. Decent coats and other clothes were handmade, expensive and pawnable. The monkey on the table in verse two was the demand for payment of a mortgage or other secured loan. If knocked off the table or ignored it would go unpaid and accrue interest, requiring the coat to be pawned again. The stick itself may also be rhyming slang - "Sticks and Stones: Loans".
You may be wondering, what does a children’s rhyme have to do with Part 3 in Gryphon’s series on ‘Keeping It Real’? The explanation is twofold; this is as interesting and charming as it gets when you are purveyors of rules-based investment products because there is not a great deal of mystique or mystery in the product. Secondly, rules-based products, unlike many other investment products, have a set of rules that need to be followed and repeated as you would a rhyme. Let’s unpack this…
In our previous article we looked at how a simple annual fee can erode wealth over a long term if it is not controlled. Beyond this, in order to be able to establish how to compare the costs of various unit trusts, there are four types of fees to consider:
Initial fees - initial fees are not usual anymore and can/should be avoided;
Performance based fees – these fees can be tricky but must be clearly understood and if you have a PhD in applied mathematics you shouldn’t have a problem;
Annual management fee - this fee is usually unambiguously stated on the fund fact sheet;
Total Expense Ratio (TER) - the TER is the biggest component of fees associated with managing and operating an investment (excluding administration, financial planning and servicing fees). These costs consist primarily of management fees and additional expenses such as, legal fees, auditor fees and other operational expenses.
Pension fund reforms prescribe a change in investor responsibility which make understanding an investment product an obligation. Any savvy investor will research two aspects of an investment opportunity – the costs and the expected return. Increasingly investors are realising that the only variable that can be controlled when investing are the fees that you pay, whereas equity market performance turns out to be somewhat random, and certainly unpredictable. Equity funds that outperform today were probably yesterday’s poor performers…and where they’ll land up tomorrow is in the lap of the gods. Our research leads us to believe that the majority of funds that beat the market do so more as a result of luck rather than skill.
But leaving the arguments of picking funds aside, is there any way to save on fees while maximising returns?
The short answer: Yes.
The unit trust General Equity Sector currently has R282bn in assets under management (AUM). Of this, R262bn of this has a three-year track record (in 139 funds). During this three year time period the market returned 5.07% per annum.
Assuming that the numbers in the above table were constant throughout those three years:
85% of available funds underperformed the market;
95% of assets under management underperformed the market;
97% of fees paid by investors were to underperforming funds.
This is not a once off, random event. If we look at the same scenario over five years, the results are not much different:
86% of available funds underperformed the market;
90% of assets under management underperformed the market;
88% of fees paid by investors were to underperforming funds.
We spoke earlier of using the TER (Total Expense Ratio) as a litmus test for costs. What, you should ask is, does this matter, or better yet, how much can this matter?
By taking the ten funds with the lowest TERS available in the market, we managed to outperform the ten most expensive funds on a three-year and a five-year basis:
All ten of cheapest funds were based on some form of indexation or followed a passive approach to investing. Gryphon was one of these. Had investors used the cheapest options available, over 3 years they could’ve earned R153m (R17,000 * [3.42%-4.32%]) more in performance and/or saved R306m (R17,000 * [2.2%-0.4%]) in TER alone.
How closely can investors be looking at fees if 95% of total fund expenses in the General Equity space goes to the lower performing funds? And, probably the more critical flip-side to this question is, if lower priced funds perform better than the expensive ones, why are the ten lowest priced funds only holding 2% (three-year data) of the retail assets under management?
This is a classic caveat emptor scenario. While the imbroglio of costs may seem to be overwhelming initially, you can approach it as you would the child’s game of ‘Pick-Up-Sticks’; pick each one up carefully and be aware of its impact – what moves? If it seems so much easier to rather just throw your hands up and simply invest where the herd is investing, if that weasel goes POP!, here’s hoping your coat is handmade, expensive and pawnable.
If you missed part 1 and 2 of this series, click on the images below...
Part 1: Keep It Real
Part 2: Indexation With Purpose