When investing, fees are one of the most discussed and often misunderstood aspects of an investment fund. Many investors naturally focus on fees because they have a direct impact on the amount of money that remains invested and compounds over time. A difference of even a small percentage in annual fees can have a meaningful effect on long-term wealth creation, especially over periods of many years however, when reading the fees section of a Minimum Disclosure Document (MDD), it is important to understand what each fee represents and how it fits into the bigger picture of investment performance.
The fees shown in an MDD are designed to give investors transparency about the costs associated with investing in a particular fund. These costs are not usually paid separately by the investor but are deducted from the assets of the fund, meaning they reduce the investment return that the investor ultimately receives. This is why understanding fees is important, because every rand paid in fees is a rand that is no longer available to contribute towards future growth.
One of the main figures investors will see is the Total Expense Ratio (TER). The TER represents the percentage of the fund’s assets that are used to cover the ongoing operating costs of managing the investment. These costs can include the investment manager’s fee, administration costs, audit fees, regulatory expenses, and other operational costs required to run the fund. For example, if a fund has a TER of 1.5% per year, this means that approximately 1.5% of the fund’s value is used annually to cover these expenses.
Another important measure is the Transaction Cost (TC). While the TER covers the ongoing costs of running the fund, transaction costs relate to the costs incurred when buying and selling investments within the portfolio. These costs can include brokerage fees, taxes, and other expenses linked to trading activity. Transaction costs are often overlooked because they are not always as visible as management fees, but they can become significant in funds where there is frequent buying and selling of investments.
The combination of the TER and transaction costs is shown as the Total Investment Charge (TIC). The TIC provides a more complete picture of the overall cost of investing in the fund because it includes both the ongoing expenses and the costs associated with managing the portfolio’s investments. When comparing different funds, looking at the TIC rather than only one fee component can provide a more accurate understanding of the total cost of ownership.
Some funds, particularly those with performance-based fee structures, may also include a performance fee. A performance fee is an additional fee paid to the investment manager if the fund achieves certain performance objectives. The idea behind this type of fee is to align the interests of the investor and the investment manager, as the manager is rewarded for delivering strong investment results. However, investors need to understand how the performance fee is calculated because different funds can use different structures.
One important concept linked to performance fees is the use of a high watermark. A high watermark is a mechanism designed to ensure that investors only pay performance fees when the fund achieves new levels of performance above previous highs. For example, if a fund grows from R100 to R120 per unit and a performance fee is charged, but the fund later falls back to R110, the manager cannot simply charge another performance fee when the fund returns to R120. The fund must first exceed the previous high point before a new performance fee can be earned. This protects investors from paying performance fees repeatedly for simply recovering previous losses.
Although fees are an important consideration when choosing an investment, they should not be viewed in isolation. A fund with higher fees is not automatically a poor investment, just as a fund with low fees is not automatically the best choice. The most important question is whether the fees are justified by the value delivered through the investment strategy, risk management, and long-term returns achieved.
When reviewing performance figures in an MDD, investors should remember that the returns shown are already after fees have been deducted, which means the performance figures represent the actual investment experience after the costs of managing the fund have been taken into account. A fund with higher fees that consistently delivers better risk-adjusted returns may provide greater value than a lower-cost fund that produces weaker results. Conversely, a high-fee fund that does not add value through improved performance or better risk management may not justify the additional cost.
Ultimately, understanding fees is about finding the balance between cost and value. Fees matter because they influence long-term outcomes, but they are only one part of the investment decision. By understanding the different charges shown in an MDD and considering how those costs relate to the returns and investment strategy of the fund, investors can make more informed decisions and evaluate whether an investment is suitable for their own financial goals.