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It’s common knowledge that when you engage in financial transactions a range of costs are incurred. But investors may not fully appreciate the long-term impact of these costs on their total return. Whether a fund is actively or passively managed, you will have to pay to buy and sell securities. These will differ based on whether you’re investing in an actively managed portfolio, which requires ongoing research and analysis to identify and capture attractive market opportunities, or a passively-managed, portfolio, which replicates the performance of a pre-selected index, often by rebalancing (buying and selling) the underlying shares to achieve target exposures of that index.

When investing in the equity market, be it in your personal capacity or via a professional investment manager, the following explicit transaction costs apply:

  • Brokerage charged for executing a trade on the JSE, through a registered member (on average 0.10%)
  • VAT (on Brokerage), currently 15%
  • Strate (Pty) Ltd fees for electronic settlement at 0.05% per contract note,
  • Securities Transfer Tax (STT) at a rate of 0.25% on the purchase of a security, and
  • The Investor Protection Levy 0.0002%

A practical example helps highlight the impact of these costs on investments. Take a R10,000,000 investment in a hypothetical FTSE/JSE Top40 portfolio. Based on the execution costs above alone, a few elementary sums reveal that it will cost approximately R41,520 (0.42%) to deploy this cash, and another R16,430 (0.16%) to liquidate the same amount held in physical shares. Sure, these do not seem like massive amounts, given the size of the investment, but they can certainly become a significant portion of the investor’s resultant gain or loss, especially in environments where equity markets are stagnant. In fact, in scenarios where the underlying investment grows/declines by less than 20%, these execution costs alone comprise a considerable 2.5% of the resultant gain/loss!

It is precisely these expenses that fund managers, at a minimum, must clear if they want to have any hope of generating positive performance for their clients on a net basis. That is the return client’s will see on their investment statements. Active equity managers attempt to do this – with arguably limited degrees of success – by picking shares based on the outcomes of copious amounts of fundamental research. The cost of these efforts is then passed on to clients in the form of management fees. Passive managers, on the other hand, have little room to mitigate these costs, which undoubtedly makes a pure passive tracker fund less likely to meet its investment objectives on a net basis.

A critical aspect of our Prescient Core Equity Fund strategy is to minimise the execution costs of investing while maintaining full equity exposure. While we cannot escape these explicit execution costs, we manage our equity exposure in a way that minimises these costs and increases the likelihood of meeting  our investment objectives.

Consider the same R10,000,000 investment but using FTSE/JSE Top40 Futures contracts instead of the physical shares. When entering the contracts, the investor gains the same effective exposure as purchasing the underlying shares but, critically, at a fraction of the execution costs. Execution costs applicable in this instance are:

  • Brokerage of approximately R10 per ALSI40 contract
  • Clearing fees of 0.001% on the effective exposure
  • VAT (levied on Brokerage and Clearing fees), currently 15%

To get the same R10,000,000 exposure using ALSI40 futures contracts at 60,000 index points per contract and a standard multiplier of 10, the investor needs only 16 contracts. These execution costs amount to just under R300, which is a massive 98% saving on execution fees compared to buying and selling the physical shares. 

To illustrate the savings, consider the execution cost difference on the same R10,000,000 portfolio, with an assumed 10% annual turnover per year. The numbers show that over a period of about 20 years, the portfolio will have saved just over R500,000 by simply being prudent in the way investments are executed while enjoying the same market return. Remember this R500,000 is not obvious to the investor. It accumulates in the invested amount, and that higher base then generates an enhanced return. In this example, the value of this saving amounts to 12.5% of the initial investment – an amount that is hard to ignore. This is one of the reasons we prefer – to the greatest extent possible – to utilise such contracts to manage our equity exposure. Without these, the higher expenses, which are borne by the fund, eat into the alpha generated, and ultimately erodes the gains that end up in your back pocket. DM/BM

Author: Ashleigh Allan, Equity Dealer at Prescient Investment Management.

Disclaimer:

  • Prescient Investment Management (Pty) Ltd is an authorised financial services provider (FSP 612).
  • The value of investments may go up as well as down, and past performance is not necessarily a guide to future performance.
  • There are risks involved in buying or selling a financial product.
  • This document is for information purposes only and does not constitute or form part of any offer to issue or sell or any solicitation of any offer to subscribe for or purchase any particular investments. Opinions expressed in this document may be changed without notice at any time after publication. We therefore disclaim any liability for any loss, liability, damage (whether direct or consequential) or expense of any nature whatsoever which may be suffered as a result of or which may be attributable directly or indirectly to the use of or reliance upon the information.
  • Supervised representative
  • Collective Investment Schemes in Securities (CIS) should be considered as medium to long-term investments. The value may go up as well as down and past performance is not necessarily a guide to future performance. CIS’s are traded at the ruling price and can engage in scrip lending and borrowing. A schedule of fees, charges and maximum commissions is available on request from the Manager. A CIS may be closed to new investors in order for it to be managed more efficiently in accordance with its mandate. There is no guarantee in respect of capital or returns that reflects the return for investors who have been fully invested for that period. Individual investor performance may differ as a result of initial fees, the actual investment date, the date of reinvestments and dividend withholding tax. Full performance calculations are available from the manager on request.
  • This document is for information purposes only and does not constitute or form part of any offer to issue or sell or any solicitation of any offer to subscribe for or purchase any particular investments. Opinions expressed in this document may be changed without notice at any time after publication. We therefore disclaim any liability for any loss, liability, damage (whether direct or consequential) or expense of any nature whatsoever which may be suffered as a result of or which may be attributable directly or indirectly to the use of or reliance upon the information.
  • Prescient Management Company (RF) (Pty) Ltd is registered and approved under the Collective Investment Schemes Control Act (No.45of 2002).
  • For any additional information such as fund prices, brochures and application forms please go to www.prescient.co.za
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