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ETFs are low cost, but beware the downside

Exchange traded funds (ETFs) have become popular because of their low cost and simplicity.  In addition, proponents of ETFs point out that the average active fund manager typically fails to outperform the market. 

However, they neglect to mention that because an ETF owns the same shares as a given index, such as the FTSE/JSE All Share Index (ALSI), it can never outperform it and when the index goes into negative territory, so will the ETF that tracks it, says Marius Fenwick, Chief Operating Officer at Mazars Financial Services.

“The argument that the average asset manager fails to outperform the market is a little hollow as there are plenty of managers that do, particularly in volatile markets,” he says.  Granted, it can be difficult to choose the right manager, but that’s where a professional, independent financial adviser can help.

According to Fenwick, last year, 71% of the 79 general equity unit trust funds outperformed the ALSI (and therefore also ETF’s) and over three years 44% of the 73 general equity funds did the same. Over five years 39% outperformed the ALSI and the figure for 10 years is 82% of fund managers outperforming the ALSI. 

“Whether or not the average fund manager outperformed the ALSI, there were still more than enough quality unit trusts that beat the index to choose from over each of the periods,” says Fenwick.  Identifying these managers and building a portfolio of outperforming managers is where IFAs can add value.   

Last year, for example, the Mazars Financial Services Equity Portfolio, which comprises a select collection of unit trusts, returned 7.02% to investors, whereas the ALSI delivered a modest 2.7%.  And over 10 years, the Mazars portfolio returned 20% per annum, outperforming the ALSI’s 13% by a solid 7% per annum.  In addition, its conservative portfolio, which holds up to 40% in equities, delivered 11,36% last year in comparison to the sector average of 6.26%.

“The significant outperformance of our conservative fund shows what can be achieved through strategic asset allocation in difficult markets,” says Fenwick. 

Considering the value added, Fenwick believes that the fees charged by financial advisors that truly add value are justified. Advisory fees typically range between 0,25% to 1,0% per annum depending on the portfolio size. Even at the higher fee scale of 1,0% per annum, the Mazars equity portfolio outperformed the ALSI by in excess of 3,5% in 2011 and by in excess of 5% per annum over the past 10 years.

“While many investors may shy away from choosing a manager, preferring the simplicity of an ETF, they’re actually doing themselves a disservice in the long term, despite the higher fees,” Fenwick concludes.

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