There is an old saying about throwing the baby out with the bathwater and while the exact origin of the phrase is uncertain, the meaning is clear in that it suggests an avoidable error where something good is tossed out in haste to get rid of something (bad). To my mind this might be the case when it comes to fees and costs in the unit trust industry and especially with the removal of rebates paid by asset managers. As someone who is trying to run a fee-only financial planning practice, the paying of rebates to financial advisors by some unit trust funds presents some challenges…but they are not necessarily all bad.
For the purpose of this article, a rebate is defined as a fee that is paid to the intermediary by the asset manager from the annual management fee. There is no increase in the fee to the investor and also no decrease in the fee if the rebate is not paid. In other words, the asset manager effectively earns less on the funds where rebates are paid. To my mind, in a regulatory environment where full disclosure and transparency is regulated, this presents a potential win-win situation for the client and the planner.
The scenario is typically as follows:
Funds A and B each levy an annual management fee of 1.5% (excl VAT), however, Fund A pays a rebate of 0.5% to the intermediary while Fund B retains the full annual fee as their own. An investor with R1million in each of the funds would effectively pay R15000 pa in management fees. This is deducted by the fund at a rate of 1/12th of 1.5% each month and is paid from interest/dividends before they are distributed to the investor – in other words, the investor does not actually pay this – it is withheld from his distributions by the asset manager. In the case of Fund A, the rebating fund, R5000 of the R15000 will be paid to the intermediary in the form of a rebate. Fund B would retain the full R15000.
Consider the following: an investor approaches a financial planner for advice with respect to investing in Fund A or B…all things being equal (in terms of returns, style etc) there is a distinct advantage to the client to invest in the fund that pays a rebate to the advisor because he will not only pay a lower annual fee on the fund but his advisor will also be paid by the fund. The total fund fee is still the same as fund B but at a rate of 0.5% pa, the advisor will earn R5000 from the asset manager. By law, this fee should be disclosed to the client and in our practice we will offset this amount against the cost of the advice. And because units are not sold to pay the fee, there is also no capital gains event for the investor when the fund pays the intermediary.
If we used Fund B then the client would pay an annual fee of 1.5% and would also then pay our advice fees on top of this…in this scenario, the only one winning is the asset manager! To my mind, the question should therefore be this, “why are more asset managers not paying rebates?” Those that pay rebates from their fees are effectively saying that they are “happy” to have a lower annual management fee on their fund and until such time that new unit classes (clean classes) are created, the paying of rebates seems to me to be fair to both the client and intermediary. If there were “clean class” funds then if we used Fund A, the annual fee would be 1% to the client compared to Fund B where it would be 1.5%. In this scenario if we use fund A the client would pay a lower annual fee than Fund B…in either scenario we would still invoice the client but the lower annual fee on Fund A would mean lower total fees to the client and would also probably result in greater returns over time.
There are also some funds which will pay on-going advice fees to advisors but not from their annual fees – instead they will sell units from the client’s fund to pay the intermediary. This not only increases the actual annual fee that the client pays but also creates a potential capital gains tax issue for the client. I don’t believe that this is good for the investor.
Under the current practice of rebates, one of the questions I often have to ask myself is does this create a potential conflict of interest? Are we using Fund A rather because it pays a rebate? I have rationalised it as follows: we are going to get paid for doing the work, whether the client pays us directly or the fund pays us from their fee makes no difference so long as we are disclosing the fees in full to the client and there is no “increase” in the cost to the client. If we can get a win-win scenario for the client and for us, how can this be a conflict of interest – rather, surely it is acting in the client’s best interests?
If we are going to see rebates done away with, then we need to see a significant decrease in annual fees levied by asset managers…those that are currently paying rebates are probably ahead of the curve!
