By Michael Dodd, Senior Fund Analyst at Morningstar SA
South African investors saw fund fees continue to trend lower in 2023. The trend of declining fund fees is one that is observable and consistent across most global markets. Both in South Africa and globally there are several factors that have played a role in lowering fees. These include factors such as the continued growth of passive investing, increased competition among asset managers and an evolution in the economics of advice. This has been a positive for investors, who have benefitted from these dynamics and have saved money in fund fees as a result.
This study analyses the trends in South African fund fees to end-December 2023. Specifically, it considers only fund share classes that are classified as retail share classes. It does not include fund share classes that are not readily accessible by all investors, such as restricted or ring fenced institutional or platform share classes that are only available to certain investor types.
The study uses the Total Expense Ratio (TER) as the measure for South African fund fees. The TER is the global standard used to measure the total cost of the fund to the investor. It is expressed as a percentage of the net asset value of the fund, and includes expenses such as fixed management fees, performance-based management fees, administration costs, audit fees, custody fees, trustee fees, bank charges and taxes. Notably, it excludes transaction costs, which in the South African fund context are added to the TER to calculate a fund’s Total Investment Charge (TIC).
The study looks at average fund fee trends through both an equal-weighted and asset-weighted lens. Both are important, as they offer differing perspectives: equal-weighted average fund fees capture the trends of fund fees charged by the industry, while asset-weighted average fund fees capture the fund fees that are paid by investors. In general, one would typically expect asset weighted average fees to be lower than that of equal-weighted average fees, as larger funds should benefit from economies of scale that allow them to keep certain elements of their TER comparatively lower and allow these benefits of scale to be passed on to investors.
Fees continued to decline in 2023
In 2023, the average asset-weighted South African retail fund TER was 1.15%. The average asset-weighted TER for active funds was 1.17%, while the same number for passive funds was 0.57%. As the South African fund landscape remains dominated by actively managed funds, it is unsurprising to see the overall average being very close to that of the average for active funds.
Exhibit 1 below captures these average equal-weighted and asset-weighted fund fee trends over time for all South African retail funds and separates out active and passive funds. In general, the direction of travel for fund fees over time has been lower. However, when comparing the average fund fee trends in South Africa to that of a market like the United States, where passive has taken a much larger share of the market than it has in South Africa, the decline has been on a much slower trajectory.
Within the South African numbers there is an interesting observation to be made in looking at the average fees for passive funds. Contrary to what you would expect, the average asset weighted fund fee for passive funds is higher than that of the average equal-weighted fund fee. What this would suggest is that when new passive offerings come to the market, they are undercutting the incumbent offerings from a fee perspective and the incumbent offerings have not adjusted their fees lower in response to this new competition.
Multi-asset class funds remain the priciest fund categories
Exhibit 2 below looks at the average asset-weighted fees across Morningstar’s Global Broad Category Groups and looks specifically at Equity, Fixed Income and Allocation (multi-asset class) funds. Due to the regulatory framework governing retirement savings in South Africa, Allocation funds have the largest market share of the local fund market. Active Allocation funds are the most expensive South African fund category, with an average asset-weighted TER of 1.39%. Active Equity funds are only slightly cheaper, with an average asset-weighted TER of 1.35%, while the average asset-weighted Passive Equity fund TER sits at 0.61%. Fixed Income funds are generally cheaper than Allocation and Equity funds, with the average asset-weighted TER for an Active Fixed Income fund being 0.75%.
Unpacking these broad categories further, Exhibits 3 and 4 below look at the fee trends at the Association for Saving & Investment South Africa (ASISA) category level for the ten largest fund categories (excluding Money Market funds) over the last five years.
While the declining fee trends are generally observable across the different ASISA categories, there are a few interesting observations that can be made in this data:
- Firstly, the observation that multi-asset class portfolios cost you more than single asset class portfolios remains broadly true. This is particularly observable within income funds, where the average South African Multi-Asset Income fund costs significantly more than short-term income funds (SA IB Short Term) and bond funds (SA IB Variable Term).
- Secondly, within the equity categories a South African Equity fund costs you less than a Global Equity fund. However, this gap has been closing in recent years as the uptake in the use of lower-cost passive funds has been far greater in the Global Equity category than it has in the South African Equity category. In addition, the average asset-weighted fund fee in the South African Equity category has seen a notable increase since 2021 as two of the largest funds in the category received more in performance-based fees in the last two years as their respective performance profiles turned around.
- Lastly, as illustrated by Exhibit 5 below, investors are voting with their feet when it comes to investments in more expensively priced funds. Across these ten ASISA categories an average of 36% of assets are allocated to funds in the two most expensive quintiles (‘Above Average’ and ‘High’). While the spread does differ across categories, lower-cost offerings are being well supported in ASISA fund categories such as Global Equity, Worldwide Multi-Asset Flexible and South African Multi-Asset Income.
Conclusion
Fund fees are a key consideration in any fund selection decision, and price remains one of the key pillars that we focus on at Morningstar in the evaluation of any fund. While lower and more transparent fee structures are generally better for end investors, it is important that price is not looked at in isolation as slightly more expensive funds may provide good value for money when looked at through the lens of net-of-fee performance outcomes.
Generally, higher fees do compound over time and can detract from investor outcomes in a material way. Morningstar have published numerous studies that show that fees are one of the better predictors of a fund’s potential for long term outperformance. We prefer funds with below-average expenses, and we like to see funds pass along economies of scale to investors by lowering expenses as assets increase. It is, therefore, encouraging to see through this study that South African fund fees are following along the same path as their global counterparts. While the trajectory of the decline in fees has not been as fast as what has been seen in other global markets, the direction of travel locally is a positive one for investors.
