Managed fund boom good for advisers

I don’t know what drugs Mr Douglas is on but I want some! He says “fees would continue to fall”. Would continue to fall? Fees have gone up not down, mainly due to fund managers inflicting performance fee structures onto their clients. It doesn’t stop there, the performance fee arrangements are structured, in respect of equity funds, almost always with absolute return benchmarks which means when the stock market has a very good year like last year and returns 30% then if your benchmark is a 10% return your fund manager is laughing. Incidentally and predictably these sort of unfair performance fee arrangements are illegal overseas. I am sure readers would be interested to see a reply from Morningstar on this, perhaps with some supporting data. Regards Brent

They are probably referring to more modern mutual funds schemes such as Kiwisaver, as opposed to the various antiquated or mismatched data you spew forth Brent.0.4% to 1.1% fees all up etc. No performance fee arrangement etc.

Hi Brent, it’s always good to see your contributions to Good Returns, and I’m happy to provide more clarity about my comments above. Firstly, we broadly agree with you about managed fund performance fee structures in New Zealand. We acknowledge that the aggregate total cost to the end investor has potentially increased as a result of the introduction of a number of funds with performance fees. We’ve been critical of many of these structures, especially about absolute return benchmarks. We’ve made this clear to many of the fund managers we assess, in our published research reports, and to the regulator, and we believe there have been positive changes in recent years as a result.

For example, Fisher Funds made changes to its performance fee hurdle in 2012, and put a cap on the total fee it can charge, lowering the overall cost to investors. Harbour also made positive changes to its performance fee structure in early 2012, again reducing the cost to the end investor. Finally, only a few weeks ago Elevation Capital announced that it was reducing the management fee for its Global Value Fund of Funds by more than half – again, a great outcome for investors. This is all on top of the already reasonably-priced offerings available in KiwiSaver. (If you want data on this, check out our article comparing KiwiSaver fees to those for Australian superannuation funds at www.morningstar.co.nz.)

These fee reductions have come about in large part because of increased competition and greater scrutiny. We’ve had discussions with a number of fund managers about this issue, and expect further movements. We wholeheartedly agree that fees are a very important consideration for investors, and have made this clear on many occasions. I hope this gives you the clarity you’re after. So no drugs needed!

Hi Chris

What you say makes sense but if we look over a 10 year period it is hard to conclude that fees have gone down in many areas except for KiwiSaver and in KiwiSaver perhaps the main reason fees are low is due to the actions of the Government Actuary. However in the short term, as you point out, fees are headed lower so maybe we have reached a peak.

The important issues, to my mind anyway, are that fees, as a percentage of prospective returns, are probably the highest they have ever been. And the other point is that the other problem with high fees is that they tend to force advisers into adopting more risky asset allocations and instrument selection than would otherwise be the case so as to achieve a reasonable return after fees.

Apologies for the drugs comment!

Regards
Brent

Hey Brent

I totally agree with your comments on performance fees in general (as the use of these in NZ just seems plain wrong).

Beyond this though I am interested in your constant type claims and statements. You sort of remind me of a guy I knew in the industry once called Gareth.

What returns have your clients in say a balanced type portfolio got in the last 10 years?

I want to know, so I can compare these to say NZ's worst performing "balanced" fund manager for the 10 years to 31 December 2012. According to the MJW survey this is AMP Capital who have returned 8.2% per annum before fees. Given that we have had all sorts of problems in markets, this actually seems surprisingly good.

Looking at their investment statement they charge 1.0% for their balanced fund. Now, lets assume they hide a few performance fees etc. and in reality the total fee is closer to 1.3%.

A quick bit of math says that this is roughly 6.9% after fees, although I happily admit that this could be wrong as I can't be asked checking, plus haven't even taken into account the fact that NZ investors get a tax deduction on the fees (but note that investors in your beloved passive global funds probably don't, which is something you don't seem to ever comment on).

So can you put up better returns (preferably with some sort of external check, which hopefully you will have given that we all know the need for independent checks and balances following the Ross issues)?

10 years is a long time, and I have picked the worst of the managers (I could have jumped the return up by roughly 1% per annum by picking the likes of OnePath).

The big point here I reckon is why wouldn't a client just go straight to the likes of AMP Capital and buy their balanced fund (and not use the likes of you). At 1% per annum (or even 1.3% per annum) including all the investment management, custody, tax accounting etc. it seems a good deal. I also see that AMP Capital's average transaction costs appear to be around 0.22% per annum - which I am guessing is lots less than the brokerage your clients get hit with for buying or selling assets. I also can't remember you ever mentioning that investors in direct asset like FIFs and individual fixed interest securities probably need to pay money to their accountant for checking their tax statements etc. which probably isn't free I assume.

I reckon the fund managers should get bored with your constant attacks and start writing stories about the transaction costs that get charged by retail broker/advisers, plus hidden costs like those relating to preparing tax statements for directly held portfolios of assets.

I see the transaction cost on AMP Capital's fixed interest fund are 0.05%. What do you charge clients to buy and sell fixed interest assets (or do you hide this in the yields)?

Show us your performance Gareth. Sorry I mean Brent.

Hey Chris, interesting comments but I think you are not looking at the whole story here. I know you paid by the fund managers which is fine so you do a good job justifying their fees. But why don't people go straight to AMP Capital? I'd say because an adviser tells them to go elsewhere. So you are not counting the fees the adviser charge (or have paid as a commission more like it) the trail commission and/or monitoring fee or platform fees. Yes some advisers use a platform to own a balanced fund so where do these fees fit into your analysis? Once these fees are counted the true cost to investors goes up significantly,but thats OK because you work for the fund managers not retail investors.

Hi Inspector

Funny you should ask about returns because I suggested to this website that we canvas all the major financial planning firms to get a feel for their performance data in the short, medium and long term. On the $660m we manage our average return on real money (no model portfolios or funny business) to 31/12/2012 was 7.6% pa. That includes all fees, including transaction costs. In the 12 months to 28 February 2013 our portfolios returned 15.6% after fees.

I think you will find that many advisers have underperformed even this modest figure because we reckon that a portfolio invested 40%/10%/50% which did as well as the index in each sector and assuming no costs whatsoever returned 6.7% pa in the 10 year period.

I was going to comment that you might be an investment consultant upset at the last Herald article but your comment that “investors in your beloved passive global fund don’t get a tax deduction on the fees” leaves me to believe that you are not a consultant. This really is a bit of a silly comment, without being nasty, because as you know dividends are paid after the deduction of management fees so the tax deduction question is irrelevant – you need to spend a dollar to get 28 cents of tax deduction which is stupid. The bottom line with passive funds is that there is frequently more left over to pay the 5% fair dividend tax. Funny that you should also mention problems with direct investment in FIF’s as my accountant rang me this week and said I was getting a $66,000 tax refund due to my FIF shares going down in value in 2012. I presume you know PIE’s don’t have this attraction.

As to why people wouldn’t go straight to a balanced fund that is a good question but I guess many people like to own things directly and obviously want to tailor their asset allocation for their own needs. Also a lot of people remember how badly served they have been by insurance companies in the past. I certainly don’t see balanced funds being a threat to my business in any way, shape or form.

Lastly, Inspector, I am sure many fund managers get bored with my comments but not many seem brave enough to write back under their own names. For the record I am flattered that you compare me with Gareth Morgan as I detest feral cats as well and like him I am doing something about it. Protecting our native animals is an even bigger issue than protecting retail investors.
Regards
Brent

Brent

For the year ending 31 December 2012 I think that you got absolutely trounced by all the professional managers. Accordingly to the MJW survey the likes of AMP Capital even rolled in with 13.5% for the year, while Onepath did 16.8% (and you did 7.6%. Again, if I can buy say AMP Capital's fund for 1% (even if this goes up to 1.3% if there are some sort of extras) this seems a good deal. If I was a client I would be looking pretty hard at why you underperformed all the professionals.

I didn't comment on how you might or might not have performed relative to other advisers.

I guess that 6.7% per annum you claim for the seems ok for this 10 years period, so well done. I note agains that AMP Capital did 8.2% per annum for their balanced funds for same period (and that they were the worst of the professional fund managers). Who knows though if we are doing a like for like comparison here.

Bad luck on having to get a tax refund in the 2012 year. I note that I didn't, and that the hedged global share index performed positively for the period (I have seen your comments on your views on hedging, and I can't say they seem entirely well considered, which in turn might have resulted in getting a negative return).

What is really exciting is that you did manage to get a refund on your FIF assets for 2012 at all, as when I last looked if you switched your global shares to being taxed under CV (from FDR) when you got a negative return, then while you could avoid paying the FDR tax, you could not claim back the loss, or use it against your other income. I suggest that you ring the accountant, as I can hear the man at the IRD starting his little car up. I think you just admitted to getting $66,000 that you are not entitled to (I hope your other clients didn't try and do the same thing).

As an aside I agree with the merits of individuals using FIF funds for global share in lots of cases (I just noted that you never mention things like the accounting costs associated with this. As an aside given the glitch noted above I think you might be able to ask for the account to refund his fees). The FIF tax rules are laughable in terms of how attractive they are for some individuals. That said, it is not always the case that FIF wins for everybody. I suggest that when you talk to the accountant about your tax reclaim you go through the PIE tax rules and figure out which retail investors might actually really get a big kicker from using PIE funds (regardless of not then having the ability to switch between FDR and CV on their global shares). If you can't figure this out, then post a comment up and we can help.

Given all the above in regards to tax, I am not surprised that the comment regarding tax deductability of management fees under FDR. Let's not jump into this level of technical detail, as I think you have got some more fun things to address if you think you can claim back the loss on your FIF assets.

And not everybody can comment under their own name. For that I am sure that there are plenty of people who are jealous of your position in relation to this. If you want to see the funniest demonstration of this go on linkedIn. There you have a social network, where most people who are on it can't actually put anything on without going and seeing their compliance department first.

Finally, I like your comments, as they are always good and challenging, and I agree with some/many of your points. Like you I entirely agree with Gareth's position on cats. He also presented some robust challenging views for the investment management industry on things like fees, which was good. I can't say that much of what he did in terms of actually managing portfolios seemed too sensible.

Just to clarify my last comment the 7.6% pa return was for the 10 years ended 31/12 and asset allocation roughly approximates that of the average pension fund ie 40/10/50.
Regards
Brent

Graeme, thanks for your comments. Just to be clear, unlike some of our competitors, Morningstar does not charge or accept payments from fund managers for production of research or ratings on managed funds or other securities. We generate the majority of our revenue from operating a subscription-based model whereby clients subscribe to our software platforms in which our research is embedded. Our data business is also important. If fund managers wish to reproduce our intellectual property once it’s been published, they are able to license the right do so.

So it’s not accurate to describe us as “working for the fund managers not the retail investors”. Our stated mission is to help the investor, and regular readers of our research will be able to attest to this. In the near future, we’ll be publishing our third Global Fund Investor Experience Survey, which puts a global spotlight on the retail managed funds investor experience, including in New Zealand. Keep an eye out for this when it’s published. Hope that clears things up. I’d be very happy to discuss this with you in more detail offline.

OK - this makes sense. Apologies, as there was a 6.7% and a 7.6% I thought they referred to different things.

The 15.6% you have noted for the year ending February 2013 looks good if this is roughly a "balanced" type mandate (as in this is high). Obviously short terms numbers tell us little, but I would have been happy to highlight if it looked low, so have to acknowledge it looks good.

I am still interested in your $66,000 FIF tax reclaim, as I think that you shouldn't be getting tax reclaim for FIF loses, or be able to use these against other sources of income. Are you sure your accountant is on top of how FIF works.

Must admit I didnt listen much after he said refund..to tell the truth I thought he said 160k refund !!but when i read the docs it was 60k.im no expert and dont even read most of the stuff the acct sends me but i think it might be due to the fact that the acct guessed the future years income,prepaid a lot of the tax then with the intl shares going down it turns out we paid too much provisional tax or whatever.acct works for one of the big 4,honest as, and hes been my acct fr 20 odd yrs without incident so im sure the number is right although my understanding of it could be way out !!

Brent,
Suggest that you get an accountant that understands the FIF tax rules. Unless you have a massive exposure to certain assets that must use a forced CV,you are unable unless deemed to be a professional trader to obtain a tax credit. And what professional traders would bother to buy your beloved passive funds?
Look forward to the bill from IRD plus the penalties. And of course your accountant will not be held responsible.

Whatever realist..I'm no tax expert but when the 60k turns up in my bank account ill let you know...cashflow is king remember...and in the meantime have that apology handy.

I would be interested in what a real tax expert has to say about this discussion! It seems to me none of you know the whole story about tax and incidentally do any of you sell yourself to clients as a "tax planner"?

Interesting call Graeme. I thought Brent had his hand up, so I was surprised that you have cast a shadow over his expertise and knowledge. Then again, he also has also plainly highlighted that he has no tax expertise in his comments above, so no harm by you there I guess. I think his honest approach is great.

However, both of you claiming he has no expertise seems to run counter to what you sell to your clients. My logic for this looks like this.

I note that on your (and Brent's) website that your philosophy embraces (amongst other things) combining: "the benefits of direct investments, low fees, and tax effectiveness with a focus...." (My point: How do you know something is tax effective for the different clients you work with unless you have expertise in regards to tax?).

Also, the website notes that "we can typically improve long term after tax, after fee performance by 1% - 2% per annum." (My point: How do you claim to improve after tax returns for your clients without expertise in regards to tax?).

And not to miss that your investment approach avoids activity for your clients "that could compromise their capital gains tax free status." (My point: You clearly must have expertise in regards to this complex area, as otherwise you might inadvertently do something that compromises your client's tax-free status).

It defies logic to claim that you can improve after tax performance for a client without have a good knowledge of tax (e.g. expertise). As such I think the group claiming tax expertise appear to be you and Brent. Note that this sits comfortably with what I would expect, being that any proper analysis of an investment (for a client) would include taking into account the tax implications of making that investment.

As any investment statement (including the ones for direct investments) will highlight, investment decisions have tax consequences. Accordingly I would think that advisers understand enough about tax to support their recommendations, or they need to be working hand in hand with other groups who can provide this level of advice.

I have sufficient knowledge of tax to know that Brent's should not get the refund he claimed for loses on his FIF global share funds (or offset this against other sources of income).

Brent's claim of no tax expertise seems to run counter to what is on your website.

Hi Inspector

Graeme is out of the office at the moment so I thought I would respond although he may add his 50 cents later. There is a simple answer to this and that is our firm gets independent expert advice from accountants on tax. Having said that it is only pretty superficial stuff as regards the impact of FIF and the conclusion is, predictably, the need to focus on investments which pay a reasonable dividend and have low fees. Something that we would do anyway. So the way we know something is tax effective for clients as regards FIF is by looking at the yield of the investment after fees and obviously the lower the fees the higher the yield.

Your question “how do you claim to improve after tax returns for your clients without expertise in regard to tax” can be simply answered by the fact that we endeavor to improve returns pre-tax which obviously flows through to after tax returns. The products we use and our monitoring fees are on average 2% below that of our competitors so there is a 2% improvement on portfolios of say $500,000. Having said this I can assure you I am not after any new clients unless they have more than $5 million! You also say, and I am not trying to pick a fight here, that “I would think that advisers understand enough about tax to support their recommendations”. If that is indeed the case why would they recommend high cost PIE funds which are subject to the 5% FIF tax yet have a negative yield after management fees and monitoring fees. In addition they don’t benefit from the tax effect of falling markets. This is particularly relevant to my clients because they are all after income so buying a PIE fund with no dividend and subject to a 5% FIF tax means their cash flow after tax is effectively negative. This doesn’t make sense to me but I must go back to that original declaration that I am not a tax expert. Hope this answers your queries and do you have any thoughts on the negative cash flow, after tax, of many international PIE funds, particularly after monitoring fees are taken out. Regards Brent

Brent, you should check out the many wonderful providers of CPD in regards to tax implications to investors.

I know that you are strong proponent of the validity of CPD.

Inspector,

Brent has answered for the firm, my point was you were arguing FIF rules as a tax expert which I doubt you are and you were making comments on Brent’s tax position which again you don’t know.

Now I’m interested in knowing what level of tax expertise you claim to have. Well Inspector (if that’s your real name) let’s have a look at your website and see what expertise you claim. We all pay tax so we all have some knowledge but how much knowledge/expertise does an AFA need to call themselves a tax planner and charge fees accordingly? From what I’ve seen of the AFA qualification tax forms a minimal part of the course. You can’t call yourself a tax expert after doing that amount of study. What appears to be the practice is that “a tax planning service” is included in the standard 1% pa monitoring fee. Client’s might also use an Accountant to do the accounts for their Trust and would therefore be paying twice! I’m also wondering how many CPD hours are necessary to keep up with evolving tax law to enable an AFA to call themselves a tax expert such as a Chartered Accountant might? I know the standard answer from the FMA is the adviser has to identify their own needs, leaves a bit too much to the imagination, I think.

Stan, you are joking aren't you?

Hi Stan

I have enough trouble keeping up with the investment scene and I leave tax to the people who know tax i.e. Accountants. I think it is ridiculous that someone could do two hours of CPD and then think they can advise retail investors on their tax position. Goodness knows the legacy that some firms have left thinking they could advise on family trusts a few years back. Financial planners have enough on their plate getting up to speed with best practice as regards investment. They should leave tax and legal issues to people who know what they are doing. Would you employ a veterinary nurse to do a brain transplant? LOL

My point being that you seem to rattle off various tax advantages and disadvantages but are seemingly unfamilar with your own situation. I would suggest you brush up before spouting various tax advantages with advantages in the way you structure your clients investments.

Graeme/Brent

You should be aware that Authorised Financial Advisers on their FSP registration have the following choices available:
• Financial advice
• Financial advice and investment planning services
• Discretionary investment management services
• Financial advice and discretionary investment management services
• Financial advice, discretionary investment management services and investment planning services
• Financial adviser services in relation to category 2 products only
• Financial adviser services to wholesale clients and provision of class services

Very few financial advisers are taxation specialists and clients do not expect them to be. Their expectation would be that their adviser should have a working knowledge to the tax rules as it should influence the individual investments and the portfolio as a whole that the adviser recommends. This should also apply to the tax treatment of any currency hedging used by the various fund managers. Unfortunately it seems that some advisers are not up with the play when regards to the impact on taxation for their clients.

The choice as to whether an adviser uses a PIE version of an International share fund or for example the FIF AUD Wholesale Unit Trust may depend on the strategy being employed or if the client does not exceed the de minimis. Obviously the FIF version is more tax friendly in a down year as CV can be used over the whole of the clients portfolio.
A good set of taxation accounts such as those that investors who use the Aegis wrap platform receive should ensure that there is minimal chargeable time for the client’s tax return provider when preparing returns.

Experience shows that it is not uncommon for Chartered Accountants to seek clarification on taxation matters from taxation specialists and also from their clients CFP. That is how professionals should work. They focus on their work on their area(s) of expertise and obtain specialist advice when required.

Hi Realist, those comments are fair enough. When I look at the PIE vs FIF options for clients I see high annual management fees/ridiculous performance fees for PIEs and tax disadvantages in down markets so never use PIEs for international share funds. Our average portfolio is probably closer to $700,000 so this impacts that decision as well. Personally I think that Aegis is an expensive way of helping with your tax return. Can you advise how many basis points it costs clients for Aegis? We looked at it and rejected it out of hand because of cost. Regards Brent

Hi Brent

It has been great to see so much comment and interest in tax.

On the face of it I agree with your logic that improving pre-tax returns should flow through to after tax returns. However, because of the way in which NZ tax rules work, this is not always the case.

To demonstrate this, take the example in this exchange of thoughts, being the comparison of a global equity PIE and a FIF global equity fund. As you have observed, in a year when returns are negative, a PIE is subject to FDR tax (whereas an individual in a FIF is not). This in turn might result in a PIE global share fund that has a better pre-tax return (than its FIF counterpart), providing a lower after tax return than the FIF (which has had a lower pre-tax return). Your own argument about the benefits of FIF for global shares in turn can be used to defeat your argument that focusing on maximising pre-tax returns is what is important. Accordingly, understanding tax really does matter.

It is easy to point to other examples of this such as an example an of investor who receives a pre-tax return of 15% on their fixed interest portfolio. This results in a net of tax return of around 10.1% (assuming a 33% tax rate). If another investor on a 33% marginal tax rate gets a pre-tax return of 13% on their FIF global share investment, then this results in a post tax return of around 11.3% (again it is a bit late, and I can't be bothered reaching for the calculator to check my math). The point here is that the highest pre-tax return does not always result in the highest post tax return.

Furthermore, two FIF global share funds can provide NZ investors with the same pre-tax returns, but then produce different post-tax returns (and appreciate that when I am talking pre-tax returns I am also taking fees into account). From all of your comments it doesn't appear to be apparent that you understand why this might be. Given the passion with which you promote FIFs any ready would naturally assume your expertise runs pretty deep in terms of the tax treatment of the FIF funds, which is what Stan Walker is observing I guess.

I also am an advocate in terms of the FIF funds because of the benefits that they provide for many investors. In using/recommending FIF funds investors and their advisers need to look at factors like the tax efficiency of each fund and costs of these (including the associated accounting and/or platform costs). Most importantly I think a key aspect is looking at the circumstances of the specific client, as there will be even be cases where PIEs wins out over the FIFs for some individuals. Accordingly is not correct to simply assume that a FIF global share fund will provide a better post tax return for an individual than say a PIE global share fund. This is because some individuals are able to get big tax benefits from using PIEs. The fact that I in turn acknowledge this, does not then make me some sort of crazy PIE advocate. I am simply recognising the reality of how NZ's tax rules work. To me this understanding this seems to be all part of doing proper analysis of any investment that is recommended to a client.

As a separate observation, your claim that your fees are "on average 2% below our competitors" appears to be unfounded, and potentially misleading. How can you quantify this claim? I suspect that you pick on some old hack investment products and old adviser models, and claim "there is the proof". I suggest instead that you line this claim up against your true competitors, being the large groups like private banks like ANZ and big adviser groups like Craigs IP (based on what I get charged, your claim would require you to have negative fees, which is clearly not correct). My pick is that if you compared your fees against your true competitors (who manage most of the funds in NZ) you would come up well short in terms of this claim. That said, it is your claim, so I am interested in seeing what evidence you have to support this sales pitch.

Finally, a quick note to Graeme. The great thing about the industry is the range and diversity of the people in it. I know accountants who are AFAs, tax experts who work for fund managers, and even people with investment knowledge who work for the IRD. I have sympathy with your view, as I do wonder if NZ tax laws are overly complex, so how can AFAs and the industry at large be expected to understand these? Maybe that is something for the accountants, AFA, fund managers, and tax experts to all lobby the Government about.

As you have highlighted Brent (and I agree with you), there are significant tax incentives for many individuals to use offshore FIF funds, which from a "NZ inc" perspective seems more than a little nuts. The industry should lobby to get this tax incentive removed (I am sure those of us who are farmers would yell pretty loudly if we discovered NZ tax payers were in effect subsidizing our Auzzie farming buddies). That is what is happening here with the FIF tax regime (I have only just really thought about this - and it is a really interesting thought.) Let's get on to this type of fun topic, as it actually seems that we agree on lots of stuff about the merits of FIF global share funds.

Hi Inspector, thanks for your comments. I don’t think that the point you are trying to make that pre-tax returns can result in different after tax-returns is relevant because you are using different asset classes which have different tax positions. I thought the discussion was just confined to international shares thus PIE vs FIF funds. In addition because all of my clients have large portfolios and almost all invest via a family trust their tax rates are the same so lower fees inevitably translate to higher pre-tax and after tax returns.

As regards fees we reckon that the average total annual fees implicit in plans we are putting together averages about 0.6%pa. That includes our monitoring fee and fund management fees and we use a mix of active and passive funds. In the course of my work I see investment plans from lots of different groups including the private banks and reckon that on a $500,000 portfolio the annual management fee implicit in a plan averages about 1-1.5% and monitoring fees are about another 1%. Then you can have platform fees and turnover costs on top of that. I also think that our competitors have much higher levels of turnover than we do so if you throw in large bid/offer spreads total annual costs could be around 3%. Certainly the long term performance figures of many of the largest players suggest that fees are around this level.

By the way I don’t think that our fees are low or a bargain because prospective returns are low as well. It would be great if Good Returns could get some data together on who charges what and performance as well. Perhaps without naming names. For the record I am not taking new clients at the moment so this is not a plug for new business. Regards Brent

My ASB 'growth' fund has not made a cent since day one, I think if I recollect the statement, its less than 1% over the entire time! I would of been better off, holding my 'KiwiSaver' funds in a low interest bank account. Is there a list of which funds are doing the best? I'd like to change.