SINGAPORE (Feb 5): With the interest in exchange-traded funds (ETFs), which track the performance of an index such as the Straits Times Index, the Standard and Poor’s 500 index or the MSCI indices, the only reason active funds would be of interest to investors is if they outperform these benchmarks after expenses, or are less risky.
In the last six months, active fund managers have been in the spotlight as investors, clearly dissatisfied with sub-par returns, have flocked to lower cost alternatives in the form of ETFs. Although fees charged by funds and ETFs are an important consideration when deciding which investment is better, the initial sales charge also matters.
This charge, also known as a front-end load, is levied when buying a unit trust fund via a distributor. Unlike management fees, which are paid to the fund manager and captured in the total expense ratio, the initial sales charge goes to the fund’s distributor for processing your purchase.
In Singapore, sales charges typically range from 1.5% to 5%. They are disclosed in a fund’s factsheet. In fact, most fund managers disclose their fund’s returns before and after sales charges, which investors should take note off. Why?
In some instances, sales charges can be the difference between a fund over- or underperforming its benchmark. If the latter happens, an investor would be better off investing in a low-cost passive ETF that has lower entry charges.
To illustrate the impact of initial sales charges on the above, we compared the returns of 13 Singapore-focused equity funds with three ETFs listed on the Singapore Exchange (see table). Two ETFs mirror the benchmark FTSE STI while one replicates the MSCI Singapore Index.
According to their factsheets, the active funds have sales charges ranging from 5% to 5.25%. We assume a sales charge of 0.5% for ETFs, which are the transaction fees associated with trading on the stock exchange. These fees include brokerage, stamp duty and SGX trading fees.
Over a three-year period (in Singapore dollar terms), three active funds that use the STI as a benchmark outperformed their comparable ETFs — SPDR Straits Times and Nikko AM Singapore. Meanwhile, three of the six active funds that use the MSCI Singapore Index as a benchmark beat their comparable ETF — db x-trackers MSCI Singapore IM UCITS ETF 1C DR.
But once the funds’ maximum sales charge was applied, the tables turned in favour of the ETFs (see charts).
For example, SPDR STI and Nikko AM Singapore STI became top performers relative to their active peers, gaining 2.6% and 2.5% respectively.
Previously the top performer, Singapore Dividend Equity saw returns fall from 4.1% to 2.3% after accounting for its maximum sales charge of 5%.
In dollar terms, an investor’s $100,000 investment in this fund would have grown to $107,179 instead of $112,820, a material difference of just over $5,000.
From the above analysis, it goes to show that while investors have to keep an eye on the performance fees charged by fund managers they have entrusted their money with, initial sales fees payable to distributors are just as important.
So, what options do investors have if they want to get lower sales charges?
- Ask for a lower sales charge if buying from a distributor;
- Opt for Central Provident Fund approved unit trusts, which have a lower maximum sales charge of 3%. Of the 13 funds, five are CPF-approved: Aberdeen Singapore Equity SGD, Amundi Singapore Dividend Growth AS, Eastspring IUT-Singapore Asean Equity, Nikko AM Shenton Thrift SGD and Schroder Singapore Trust Class A SGD Dist;
- Buy unit trusts through zero-sales charge platforms such as Fundsupermart or DollarDex. Note, however, that Fundsupermart charges quarterly platform fees of 0.1%. Further, the universe of unit trusts available on these platforms is limited; or
- Invest in one of the three Singapore-focused ETFs that have lower sales charges and cheaper annual fees. But also note that, at the end of the day, total returns are what investors should focus on — not just costs.
An example of how sales charges affect returns
John has $10,000 to invest in Fund A.
Assuming a 5% sales charge, only $9,500 of John’s money is invested, while $500 goes to the distributor. If Fund A had a total return of 10% (after accounting for annual management fees) for the year while its benchmark’s passive ETF returned 6%, John has outperformed by 4%.
In reality, however, John’s investment has grown to only $10,450 (instead of $11,000) — an effective return of 4.5%. In this instance, he would have been better off investing in a comparable passive ETF, which would have returned $600 and John’s investment would have grown to $10,600.
*Calculations assume single-pricing method is used
