The interesting issue of initial fees and unit trust funds

More and more unit trust management companies are reviewing the practice of charging clients initial fees. Not so long ago it would have been unheard of for companies to relinquish their juicy 5.7% initial fee. This fee has traditionally been split between the unit trust management company (2%) and the financial advisor (3%), with both amounts liable for VAT, bringing the total initial fee to 5.7%.

However, with effect from December 1st, unit trust heavyweight Old Mutual will no longer charge initial administrative fees to direct clients or to wholesale clients like Equinox. Financial advisors will still be free to negotiate initial commissions up to a maximum of 3% (3.42% with VAT) with their clients.

When money market unit trust funds were launched between 1998 and 2000, it was the norm for these funds not to charge initial fees as these funds were so closely related to bank deposits, and of course there is no tradition of charging investors to deposit their money in a bank. There are a few exceptions to the this general rule; the Allan Gray Money Market Fund and the Absa Money Market Fund charge initial fees of 0.285% and 0.4% respectively for retail clients to invest in their money market funds. However, as the unit trust industry has evolved, it has become necessary for companies to compete for inflows into their equity-based unit trusts. It was merely a matter of time before companies reduced or eliminated the payment of initial fees to both their retails and wholesale clients.

In its efforts to make sure there were no misunderstandings, the controlling body of unit trusts, the Association of Collective Investments, insisted that the most expensive initial fee applicable to any fund should be published as the initial fee. This means that even if a unit trust management company did not charge an initial fee at all, but had a contract whereby a financial advisor would be paid an upfront commission, this commission had to be reflected as an initial fee. This has been the source of much confusion.

Allan Gray was the first company to forego initial fees to both retail and wholesale clients. However, if you look up the initial fee of Allan Gray's equity funds in the business press, you will see that the funds have an initial fee of 3.42%. Allan Gray allow their financial advisors to charge a maximum of 3% of an investment as an initial fee, as well as the VAT levied on the investment; hence the fee of 3.42%.

However, as the industry has become more competitive, even the biggest companies with the best distribution networks are looking for ways to increase flows into their funds. One of the more interesting fee structures is that of Foord Asset Management. Not only does the company not charge initial fees to retail or wholesale clients, but in the event that a financial advisor advises a client to invest in Foord funds, this money is paid from an earmarked Foord account for this purpose. The company specifically does not pay any upfront commissions as they believe upfront commissions carry an inherent conflict of interest.

Some unit trust companies have a policy of dropping initial fees on index based fund. Examples of this nature that appear below are the Gyphon All Share Tracker Fund, managed by Coris Capital and the Kagiso Top 40 Tracker Fund managed by Kagiso. 

There can be confusion with respect to the initial fees of 'Funds of Funds' funds. These are unit trust funds that are mandated to invest in other unit trust funds. Most unit trust companies negotiate a zero initial fee for their investments into underlying funds, but charge their retail clients an initial fee. In the case of the Flagship Fund of Funds, managed by Flagship Private Asset Management and administered by Metropolitan Asset Management, however, the zero initial fee has been passed on to retail and LISP investors. 

Some unit trust management companies have chosen to reduce initial fees on all their funds, while others have zero initial fees on a few funds within their product range. The management companies with (All Funds) next to their name in the table below are those that have reduced initial fees on all their funds, while the ones with (One fund) or (Selected funds) are those that have zero initial fees on one or more funds only. 

Red highlight: Investors do not pay initial fees to the management company if they invest through Equinox

* Broker's fee negotiated between the investor and financial advisor

** This figure represents a 0.25% payment to the management company and a maximum initial advisor's fee of 3%.

*** Financial advisors make their own arrangements with their clients and may charge an initial fee of up to 3%.