BALANCED FUND BOMBSHELL – VERTICAL INTEGRATION & PERFORMANCE FEES

by | Sep 1, 2022

For those of you who follow the various money websites you may have seen the recent article in BizNews “Financial insider Peche drops nuclear bomb on SA performance fee-rip off” where he has had a go at some of the largest and most successful asset management companies.

We have received a couple of queries from investors asking our opinion and views around the article. Below is some context for clarity.

From RWM’s perspective I found this article interesting as it re-confirmed that we have made the right decision by partnering with Morningstar and following their advice to switch from the old school Balanced Funds to a building block approach a number of years back.

This style of portfolio construction has greatly reduced fees and delivered far superior returns which we are very proud of! Please see the graph below of our equivalent portfolio trailing returns and please take note of the far lower fees. Our Portfolio has outperformed the next best large asset management company by 2.69% per annum over the past five years and was 1.03% cheaper at the same time. This type of out performance and fee saving has a very material impact over time.

In summary we have being able to deliver better returns at a far cheaper price, which has greatly benefitted our investors. We will continue to innovate and strive to deliver both strong returns and at the same time drive fees lower!

The financial industry has been in the limelight this past week and not for good reasons… The noise stemmed from an interview by fund manager, Sean Peche, probing performance fees by South Africa’s largest fund managers. Many smaller asset managers jumped at this opportunity, stressing their differing approach to fees.

At Resolute Wealth Management (RWM), we applaud the fact the industry has been releasing material discussing fees. We feel the better educated investors are the more equipped they are to make calculated financial decisions. Although the pressures of fees were exposed, we have been concerned that these articles have provided half-truths, so we would like to provide some insight on the topic.

Let’s touch on basics, what is a Balanced Fund? A balanced fund is a unit trust fund containing exposure to the four major asset classes: Equities, Bonds, Property & Cash. The objective of these funds is to create steady, long-term wealth by balancing income generation, capital growth and risk of loss using a mixed selection of asset classes. There are various strategies in which these objectives can be achieved.

The most common investment approach is via a balanced fund. This is where the big players like Allan Gray, Ninety One & Coronation are most effective – primarily due to them providing returns investors are happy with. In Sean Peche’s interview, he identifies these managers as thieves, due to their dishonesty & “high fees”. These accusations are founded from two key factors – performance & wrapping fees.

Performance fees are very complex. The general understanding is if a fund beats a benchmark, there is an additional fee for doing so. The question mark arises with the following:

  • What is the benchmark for the fund?
  • Is the performance based on the gross or net return?
  • What is the highwater mark? (Does this watermark reset)

Our thoughts on performance fees is that they are not a deal breaker. RWM together with Morningstar, do question the fund managers about the performance fees. We are happy as long as the returns after fees are superior to majority of competing funds.

Asset managers offering balanced funds, typically offer a range of specific funds too, across various asset classes. Often the holdings in the specialized fund for that class will match the holdings for that respected asset class in the Balanced Fund. An example is the stock holdings in the Equity Fund, will often match the holdings in the equity allocation for the Balanced Fund.

Typically, the cost of the balanced fund is often more expensive than the weighted average cost of all the specialized funds. Meaning the investor will be paying a premium fee for being in a balanced fund, which is essentially just merging all specialized funds in to one fund.

Many smaller asset managers jumped to the opportunity by joining in and criticizing the larger managers. Unfortunately, their costing is often even more expensive as they use vertical integration in their approach. We have seen many “independent” financial advisors adopt this, by incorporating their own funds in the underlying holdings of their balanced funds. Double dipping in fund management fees.

All the negative aside, there is definitely a place in the market for these funds. These funds have proven to fulfill their job historically, it is evident as the AUM for these balanced funds are well in the hundreds of billions – clearly, they have worked.

That is why we follow the style of the balanced fund objective, which is to create steady, long-term wealth by balancing income generation, capital growth and risk of loss using a mixed selection of asset classes. The big difference is we have adopted a building block strategy.

With the industry maturing, there have been an array of new asset managers. Each offering unique opportunities for their focused asset class. With the independent assistance of Morningstar, we leverage their global capabilities in finding the best and most appropriate fund for each asset class and from there we construct the portfolio. This building block approach has worked well as it has allowed for a best of breed selection from 2,500 plus funds available in the South African market.

With more and more information being made regularly available on these topics, we hope the end client is the one who best understands these topics. As they are the ones who are investing their hard-earned capital in these strategies.

When industry noise around fees arises in the future, we recommend clients don’t view this on a one dimensional aspect, but rather as a reminder that fees are important but not at the expense of growth or investment strategies. The overall sentiment is prevalent is the below graph.