Complaints from South African financial services industry players about the amount of regulation in the industry is an attempt to deflect attention away from the most important challenge facing investors; which is high fees and not the cost of regulation.
This is according to Steven Nathan, Chief Executive Officer at 10X Investments, who says that while many may argue that regulation is a cost that is ultimately borne by investors, they fail to mention the total fees many investors’ face, which are often prohibitive and opaque. “The industry attempts to blame regulation for the cost of investing because they cannot defend their high fees.”
Nathan says Treasury explores the impact of fees on the local retirement investing sector in its latest retirement reform discussion paper entitled ‘Charges in South African retirement funds’. “The intention of the paper is not to propose a particular approach but ‘to assist South Africans in getting the best possible value for the retirement savings they make’.
“However, reading between the lines, it is apparent that Treasury advocates simple, low cost default solutions using passive investing, rather than the complex product options that currently underpin many financial intermediaries and high-cost active managers.”
He says the paper confirms that an investor paying an annual fee of 0.5% per annum will receive double the retirement income as one paying 2.5% over a 40 year period, highlighting the ruinous impact of high charges. “The number of 2.5% per annum is pertinent as, per the paper, this is the average fee paid by savers in Umbrella Pension and Provident, Preservation and Retirement Annuity Funds). This number captures some R440bn in savings and 5.4m savers. The additional 2% fee means that the retirement funds industry skims R8.8bn off these investors’ savings every year.”
The industry argues that, without compulsory saving and preservation, the remaining participants do not enjoy the full benefits of scale, says Nathan. “This is exacerbated by too many small-sized funds.”
However, treasury sees other reasons, one of which is that the retirement fund market is not competitive, says Nathan. “This manifests in poor comparability of product terms and prices, poor portability, low transparency and high barriers to entry.”
He says in addition to this, neither the level nor the disclosure of fees is properly regulated, enabling providers to manipulate both. “Without a standard measure of the cost impact, price comparisons are impossible. The paper argues that providers make it deliberately difficult for customers to compare prices to avoid price competition.”
Nathan says this complex model is used to justify layers of financial intermediaries, which further inflates costs. “Many intermediaries are incentivised to sell the industries’ products, which perpetuates the use of high-cost active asset managers at the expense of passive low-cost investing. This entrenches the incumbents. Uninformed investors are unaware of, and insensitive to, the level of recurring charges, and do not push back.”
The complexity is exacerbated by flexible fund designs, and by differentiated products and services, says Nathan. “The industry offers many options that essentially just disguise close substitutes. This practice reduces economies of scale, raises charges – and again necessitates the use of intermediaries. The industry spin creates a vortex that draws investors in, and under.”
Treasury’s paper confirms 10X’s industry experience: that it is heavily tainted by excessive fees, choice and complexity, by poor disclosure and governance, and by conflicts of interest that reveal a scant regard of the investors’ need, says Nathan.
“There are many areas in our financial services industry that require stronger regulation and stronger policing, to ensure that investors buying products from financial institutions also get a fair deal. Clearly, one of these areas is fees,” concludes Nathan.