Costs and Helpers (part 3)
Welcome to part three of a three-part quick-look at investment fees, ‘Helpers’ and how you can improve your own investment returns with minimal effort.
Having set the scene in part 1 and part 2 let’s looks at costs, Helpers’, ‘manager-Helpers’ and ‘hyper-Helpers’ using a very well know Hong Kong example.
None of the information presented in part 1 or part 2 is new or that surprising. Indeed, you would think that any reasonable person would be acutely aware of the need to keep costs down. You might also reasonably expect that governments and regulators would make sure costs were kept as low as possible, especially where people have limited choices as to how their money is invested as is the case with Hong Kong’s Mandatory Provident Fund; forced pension savings with contributions from both employees and employers.
The above image clipped from the MPFA site makes a clear statement relating to management and protection. I would argue that costs fall firmly within the scope of this statement. Regrettably this is not the case or at least it appears not to be as the ‘manager-Helpers’ and ‘hyper-Helpers’ demonstrate below.
In fairness the MPFA do have sections on their site where you can see the cost of all funds and summaries of costs across various fund types. The below table was sourced from such a page[i].
As can be seen the average FER[ii] (think cost of owning the fund when all fees are considered) across 517 funds is 1.52%pa. The most expensive FER is 3.39% and the lowest is 0.45%. Compare these numbers to the 0.52% average of circa 25,000 funds available to U.S. retail investors (see opening paragraph of part 1).
At the top of the above table we can see the highest and lowest cost Equity Funds. The costliest Equity Fund’s FER is 2.81% and is the Manulife MPF North American Equity Fund. Buffet has already told us that the best way to invest in North American equities is by buying a low-cost S&P 500 tracker (see part 2). Investors can readily buy the S&P 500 for less than 0.10%pa. So why doesn’t Manulife (and others) just offer a cheap and cheerful S&P 500 index tracker? Is it because their active managers can consistently beat the S&P500 (after all fees)? Based on the last 5 years data one could conclude that this is not the case. The below table shows net returns for the Manulife MPF North American Equity Fund against a commonly used S&P500 index tracker. Over this period the Manulife fund has trailed the index by 3.24%pa. We know that 2.81% of this is due to higher fees and the rest might be down to active decisions that resulted in returns lower than that available from the index. Over five-years these two funds have a correlation of 0.91, suggesting that the active manager is deviating only minimally, if at all, from the composition of the S&P500 making the Manulife fund a very expensive Index Tracker.
One index that you can access via some MPF fund providers is the Hang Seng Index. On the HK stock exchange this has the ticker 2800 and has an ongoing cost of 0.09%pa[iii]. Pretty inexpensive by any measure so it must be cheap to hold via an MPF account, right? Wrong, according to MPFA FER data a HK Tracker from one of the MPF fund providers will cost you between 0.71% and 1.01%pa.
The MPFA do seem to be aware of the need for cost reduction and offer a table (endnote i) to show how fund costs have changed over time. Not quite as obvious as the cost reductions noted in the U.S. in part 1. Why might this be so?
Before leaving the active vs passive comparison I’d like to direct you once again to one of my very favourite papers: The Arithmetic of Active Management[iv] by Nobel Laurette William F. Sharpe. This paper sets out the arithmetic to explain why a dollar that is managed actively must, on average, produce less than a dollar manged passively.
The math and logic are simple and, as yet, I have not been convinced otherwise.
I have no great problem with active managers charging more for investment returns that are greater than that available from a comparable index. However, I do have an issue where an index fund investment is offered (e.g. 2800 or S&P500) at an inflated price where the only outcome is one of lower returns than that which might reasonably be expected.
The cost of Private Capital Limited's model portfolios rages from 0.27%pa to 0.54%pa. We make extensive use of low-cost index orientated funds to deliver market returns for minimal fees, why don't MPF fund providers do the same? A full breakdown of Private Capital’s fees is displayed on our website. You can check them out here. We believe they compare favourably with any charging structure that we are aware of.
That’s it. Thank you for reading this three-part quick-look at investment fees and ‘Helpers’. Hopefully, you are now equipped to improve your own investment returns with minimal effort.
Finally, we have a short video on this topic: Why cost is even more important than before. You can watch the video here.
If you want to know how costs are impacting on your investment returns you are most welcome to contact us.
Links to part 1 and part 2.
Note: neither the author nor Private Capital Limited are authorised to give advice on MPF products. Thankfully this does not prevent us from informing the debate.