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TOTAL EXPENSE RATIO (TER)

What is a TER?

The Total Expense Ratio or TER of a portfolio is:

  1. a measure of the fund’s assets that have been sacrificed as payment for services rendered in the management of the fund,
  2. expressed as a percentage of the daily average value of the portfolio,
  3. calculated over a period of usually a financial year.

Why disclose TERs?

  1. The Collective Investment Scheme (CIS) industry supports a principle of disclosure and transparency to its investors. TERs have been implemented in the interests of investors, as these should assist investors and their advisors to understand the disclosure better.
  2. TERs enable investors to evaluate their portfolios by quantifying the costs incurred in the management of the fund in a single number so that the impact of these costs on returns is clearer.
  3. Costs matter - investors should understand the costs they are paying for and the value they are getting for their money. The TER methodology was selected as the concept of expenses is well known and understood by all consumers.
  4. There is international precedent for using TERs to measure expenses elsewhere in the world.

Expenses included in the TER calculation

Costs incurred in the prudent operation of a fund are included. The costs are deducted from the fund’s assets.

  1. Management fees (including performance fees)
  2. Fixed operating costs:
    • Custody and Trustee fees
    • Audit fees
    • Bank charges, other than those charged by an investor’s bank
  3. Value Added Taxes
  4. Liquidity costs:
    • Net negative interest charges (this is applicable in the unlikely event of a fund owing interest to a bank as a result of temporary liquidity pressure)
  5. For investments in other funds:
    • Weighted portion of the underlying portfolio’s TER (for funds of funds)
    • Upfront fees
    • Exit fees or reduction of redemption
  6. Where income is earned by the providers of scrip lending services and if this income is not passed back to the portfolio, such an amount that is retained by the provider must be included.

Investor expenses not included in a TER

Costs that are incurred directly by the investor and not the fund itself are not included, such as:

  1. Costs of entry to an investment, i.e. Initial fees.
  2. Initial and ongoing costs for financial advice – if applicable.
  3. Other costs incurred directly by the investor, because of the investment, e.g. bank charges.
  4. Exit costs.
  5. Costs that are related to specific products, where these products invest in collective investment schemes, such as some life and LISP products. An example of this would be the cost of a Retirement Annuity which invests in collective investment schemes.

The above-mentioned expenses are not included in the TER calculation as:

  1. They do not form part of the actual fund investment.
  2. They should be disclosed separately to investors, e.g. by the life company, LISP, bank and/or the intermediary.
  3. They are often of a once off nature.

Brokerage and transaction costs

Brokerage and expenses relating to the settlement of transactions and taxes incurred on these items, i.e. Vat on brokerage, UST and stamp duty, do not need to be included in the TER calculation.

This decision was taken:

  1. To align the CIS industry’s TER to other expense ratios used elsewhere in the world.
  2. To enable more accurate comparisons of TERs of local funds to TERs of international funds.
  3. Transaction costs will be incurred regardless of the capacity in which such a purchase is made, e.g. purchasing an equity in a private capacity or for an underlying asset in a portfolio.

Performance fees

  1. Performance fees must be included in the TER calculation.
  2. Performance fees must also be disclosed separately. This is to enable investors to distinguish between costs that may be charged to a portfolio regardless of its performance and a performance fee that may vary significantly from one year to the next. The cost of the performance fee, in rand terms, will be disclosed as a percentage of the average net asset value of the portfolio.

TER vs annual management fee

  1. An annual management fee (AMF) is the fee a CIS Manager charges for asset management and fund administration. It is expressed as a percentage of the portfolio’s assets under management.
  2. A TER, as previously stated, is comprised of the actual expenses paid out of a fund for the management of the fund and it includes the annual management fee.
  3. The TER will therefore be higher than the AMF.
  4. The costs included in the TER calculation are not new; they are disclosed in a portfolio’s financial statement for the relevant financial period.

Who will calculate the TER?

  1. The CIS Manager will calculate and publish a TER for each portfolio under its management on a quarterly basis.
  2. Each class of a portfolio will disclose its unique TER that will be comprised of costs that are specific to that fee class.

Where will TERs be disclosed?

  1. TERs will be available through the newspapers and magazines that carry fund performances and charges
  2. With financial statements – interim or annual, audited or provisional
  3. In monthly, quarterly and annual reports
  4. In fund fact sheets
  5. In Internet publications
  6. With annual unit holder communications
  7. On the ASISA website with the fund prices
  8. The latest TER must be disclosed to an investor prior to making an investment. This TER disclosure must be in addition to the other disclosures required under CISCA and the FAIS Act, e.g. notifications of risk and costs.

A typical TER disclosure is:

TER: 2.65%
The Happy Equity Fund, A class has a Total Expense Ratio (TER) of 2.65%. For the period from 1 April 2008 to 31 March 2009, 2.65% of the average Net Asset Value of the portfolio was incurred as charges, levies and fees related to the management of the portfolio. A higher TER does not necessarily imply a poor return, nor does a low
TER imply a good return. The current TER cannot be regarded as an indication of future TERs.

Inclusive in the TER of 2.65%, a performance fee of 1.25% of the Net Asset Value of the class of portfolio was recovered.

Quarterly Review

  1. CIS Managers will update TERs for all portfolios and classes at the end of each calendar quarter.
  2. The calculation will include all applicable costs for the previous rolling twelve-month period, to the end of the previous quarter.
  3. The new TER will be disclosed by the last day of the month in which the TER was reviewed.

A high TER vs a low TER

  1. A high TER is not necessarily an indication of a bad investment choice
  2. A high TER should not be viewed negatively if a fund outperforms other funds or adds additional value for the higher costs incurred
  3. A high TER is also not necessarily an indication of superior performance
  4. TERs are reported in a standardised manner, enabling investors to better compare the costs of their portfolios.

TERs use historical Information

  1. As is the case when calculating fund performance, a TER is calculated using historical data
  2. Past expenses are not always indicative of future costs as costs are influenced by external factors. It is therefore not possible to forecast future costs accurately – we do not know what the future holds but we can measure the past!
  3. However, the information used in the TER calculation is based on real costs, i.e. what was actually paid out of a fund; these are not projections that are based on assumptions.

Multi-layering of fees

  1. Investments in funds that have tiered structures, such as a fund of funds, are likely to have higher TERs than single funds, due to the multi-layering of fees inherent in these investment structures.
  2. FAIS prescribes that all disclosures must be made to investors.
  3. The TER of the top tier fund will not be revealing a new fee; it will simply quantify the already disclosed fees to investors in a more consumer friendly manner.

Small vs large funds

  1. In all likelihood, funds with lower assets under management will reflect a higher TER as their fixed costs per unit will result in higher TERs compared to that for funds that have larger assets under management. This is due to economies of scale.
  2. TERs for new funds:
    • TERs do not have to be calculated for funds that have been in existence for less than six months.
    • If a fund has been active for less than one year but more than six months, a CIS Manager may calculate a TER since inception

When comparing TERs

When comparing TERs it is imperative to ensure that one is comparing ‘apples with apples’. It is advisable to note that costs and TERs are just one factor to take into consideration when comparing funds and when making an investment decision. Consideration must also be given to:

  1. The sector the fund falls into – this relates to the type of fund one invests in, e.g. an equity fund invested into listed shares, or a fixed interest fund invested in bonds, money market investments and other interest bearing securities.
  2. Fund objectives – all funds have mandated objectives that investment managers set out to achieve.
  3. The structure of the investment, i.e. a fund of funds or a single tiered fund.
  4. The anticipated net, risk-adjusted return of a fund, relative to an investor’s total investment portfolio.
  5. Costs – these include both the costs included in the TER calculation and those not included.
  6. Investment risk – investors should evaluate their tolerance for risk and then match this risk profile with a suitable investment.
  7. There may be a mismatch between the term of the investment and the TER calculation. TERs will be calculated for periods of full financial years and the time an investor has been invested in a fund, may not correspond to the TER measurement period.

The implications of disclosing TERs

  1. TERs will result in costs now being more understandable.
  2. TERS should facilitate investor education and their understanding of the investment.
  3. Investors will be better able to evaluate the total investment offering, including subjective and value added information.

It is important to note that TERs and therefore costs are not the only factor to consider when making investment decisions. It is important for investors to know what they are investing in and what they are paying for.