Last month, I wrote an article on the top ten high yield money market funds in Nigeria. One of the important components of that article that seem to have caught the readers’ attention was the mention of each fund’s annual management fee or expense ratio.
Following that article, I received many comments from people asking for explanation of those two terms. As it is in my nature not to be selfish with the sharing of information, I decided to do a follow up article, so that those who asked, those who were too shy to ask, and even those still pondering whether to ask or not, can benefit from answers given to those that were “bold enough” to ask. So here we go.
No Free Lunch
It is often said that there is no free lunch in Freetown or anywhere for that matter. Indeed, “Whatever you are ‘eating’, think once, think twice, someone, somehow and somewhere is paying for it”. No place has that saying been truer than in the Asset Management business. Mutual fund managers, hedge fund managers, pension fund managers, and other fund management companies, all charge fees. The fees are the rewards they get for managing your money, searching and researching for profitable loopholes or mispricing in the market (otherwise known as “alpha” in stock market parlance), so as to make positive returns on the money you give them to manage.
In addition to charging you to manage your money, some fund managers also charge incentive or performance fee, which is a fee that is only charged if the fund manager makes profit on your money for you. Yet again, the fund managers engage the services of third-party service providers like auditors, lawyers, fund administration companies, custodians, market data and pricing service providers like Bloomberg, Reuters, MarkIT, and a host of other data providers. They pay for these services and the payment is recovered from the investor by charging various fees like audit fee, legal fee, admin fees, and so on and so forth.
[Read Also: A guide to how Mutual Funds work in Nigeria]
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Depending on the jurisdiction of the fund/fund manager and the provisions of the underlying regulations, some fund managers may pay tax fees on behalf of a fund and then shift such fees to the investors. The totality of the fees mentioned above and more, in relation to the total asset of a fund, is what is known as the expense ratio. Expense ratio is however not the topic for today, rather management fee is. I will try over the next course of time to explain each fee in details.
What is Management Fee?
By basic definition, a management fee is a percentage of asset under management that you, as an investor, pay to the fund manager. For example, if your investment with a fund manager is N1 million, and the fund charges 1% management fee annually, you will be charged N10,000 a year. Depending on the fund prospectus, such fees may be payable monthly, quarterly or annually. The most common scenario is quarterly payment, in which case the N10,000 is paid over four quarters of N2,500 each.
Irrespective of the payment frequency, the fees are charged monthly using a method that accountants call accrual accounting. That means that for your N1 million investment, you are charged N833.33 each month. But the fund manager does not get paid that money until the end of each quarter; if the prospectus so provides.
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One important thing to note about management fee is that unlike other fees such as performance or incentive fee which are contingent on whether your fund makes money or not, management fees are charged whether your fund makes money/profit or not.
Why you should pay attention to Management Fee
It is important that you pay attention to management fee as an investor because it is the largest single fee in a typical mutual fund fee structure. Secondly, it does not depend on the profitability of the fund. You pay the fee, no matter what. Thirdly, management fee percentage rates differ among fund managers and the differences, however small, add up over time. For example, if one fund manager charges 1.75% and another charges 2%, the difference is 0.25% and if you invested N1 million in the fund charging 2%, every year you pay N2,500 more in management fees which comes to N25,000 over a 10-year period, than if you had invested in the 1.75% management fee fund. The only reason to pay more in management fee is if the higher management fee fund earns more in returns.
Calculate and Compare
Pay attention to how the management fee is being calculated, because different calculation methods can yield different fees. While some fund managers calculate management fees based on beginning of month net asset value adjusted with beginning of month subscriptions/redemptions, others calculate based on beginning of quarter net asset values, adjusted with subscriptions/redemptions.
How is management Fee Calculated?
Management fee calculation is as straight forward as multiplying the fee rate by the fee calculation basis (monthly or Quarterly NAV), and divided by 12 to arrive at the monthly fee or by 4 to arrive at the quarterly fee.
Management Fees can be negotiated
In rare occasions, especially if your investment in a fund is huge. You may be able to negotiate with the fund manager on how much management fee you are willing to pay. We live in a World that thrives on competition, where there could be exceptions to the rules. So, if you are bringing huge amount of investment, don’t be shy to ask for a reduced management fee.
Fund managers issue what is called a side letter in the asset management industry. A side letter is a document that embodies special and privileged fee related arrangements between a fund manager and high net worth investors.
Where to get information on Management Fees
Fund managers usually disclose the management fee percentages of their funds in the prospectus or fund factsheets (where available). If the management fee information is buried in the expense fee information, you can ask the fund manager for information on what portion of the total expense fee relates specifically to management fee.
Don’t forget this
It is your money and you can ask as many questions as possible to make sure that you are not paying more fees than you need to. Don’t forget that management fees among fund managers in Nigeria range between 1% to 2%. Therefore, always compare and shop for the best rate for you.