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Financial Literacy
Understanding Mutual Fund Fees: Management Fee
Understanding Mutual Fund Fees: Management Fee
#MutualFund
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]
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.
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.
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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.
Financial Literacy
How to invest for retirement
Planning for retirement means planning to reduce obligation in the future by investing today.
“If you plan to retire in five years what should you be doing today?” That’s a question I got last week, and talking with the client, a lot came up which I have decided to share.
First off, What is retirement?
Nigeria’s public service has an official retirement age of 60 or thirty-five years of unbroken active working service, but in financial planning, retirement is a financial, not a chronological event. Retirement can occur when your passive income can meet your non-discretionary expenses.
You start to plan for retirement the day you start to earn an income. Your retirement plan will centre on how to generate passive income and reduce expenses. In Financial Planning, Four distinct stages are usually described in a so-called Lifecycle Chart. These are the Accumulation, Consolidation, Spending, and Gifting stages. Chart 1. Financial LifeCycle seeks to segment investing priorities, recommended asset allocation, and risk profile in a chronological timeline as the person gets older. I will take each of these stages and explain how they are linked to your retirement plan.
READ: How to choose the right Pension Fund Administrator (PFA)
Chart: Financial Life Cycle
Early years: Use Your Time and Make Money, (Accumulate)
The first stage is called the Accumulation stage. Imagine a 22-year-old who has just graduated and is a management trainee. He typically has a low credit score and assets and income are also substantially lower. What he has in abundance is time. So it’s important to deploy his time in the best way to make money. Hence in the accumulate stage, the goal is to generate cash flow either from a job, multiple jobs, working longer hours, saving, cutting unnecessary expenses, etc.
The key measure in the accumulation stage is the Savings Rate which is essentially how much of income earned or generated has not been spent. On average, the participants in the accumulation stage have fewer dependents and maintenance needs which should theoretically make it easier to save.
READ: This thread exposed everything that’s wrong with Nigeria’s VAT
Mid Years Use Your Money To Buy Assets (Consolidation)
In the consolidation stage the focus shifts from saving to investing. At this stage, the income earned and credit scores have improved. This is when the talk of buying a home or starting a business takes concrete shape because, at this stage, those dreams can be funded. Hence capacity to take on debt is improved, and debt is used to invest in assets like a home. Remember debt is simply front-loaded consumption, which means we are taking our future income to invest today, intending to repay with future income generated from today investment.
The key measure in the consolidation stage is the Rate of Return which is essentially how much has been generated from the investments made.
READ: How to choose the right Pension Fund Administrator (PFA)
Spending & Gifting Phase; Use Your Assets To Generate Cash Flow and Time (Spending and Gifting)
Why is it called the spending phase? Because that’s what the individual is doing, spending down accumulated investments. The spending will include buying annuities or perhaps relocating to another city, your dependant’s college needs, etc. At this stage, typically very few are still earning “new” income but are rather spending from the return of prior investments.
The key measure in the spending stage is the Withdrawal Rate which is essentially how much of investment can be withdrawn as cash annually to ensure we do not outlive our investments.
READ: How interest rates impact your wallet
Retirement is All About Passive Income
Passive income, which is the income we are making from investing from the accumulation and consolidation stage is now sufficient to generate income and reduce expenses to meet our expenses in the spending/gifting stage.
To give an example, assume we took a mortgage to buy a house in the Consolidation Stage, in the Spending stage, we pay no rent, thus we save cash, which reduces our Non-Discretionary Expenses. In essence, retirement is planning to eliminate your future expenses to the point where you need less income when you retire.
What Should You Invest In Before Retirement Or In Retirement?
Our objective is simple, Income. In retirement, we invest solely to make income to meet our spending needs, Risk profile is also very low because there are fewer recovery options if your investments sink.
The retirement portfolio is an income-generating portfolio that will be overweight in fixed income products. First, determine what the risk-free rate is. In Nigeria, we can take the yield on a ten-year FGN bond as a guide, this means we can have a target of 10% as our huddle rate for the long term. Thus I will recommend an 80/20 portfolio with 80% going to Fixed Income consisting of long term bonds, REITs, and other top-grade commercial paper.
However what happens if we lock in our funds for 10 years at 10% and rates jump to 20%, meaning a loss to our portfolio. To avoid this risk we can create a bond ladder, where we break down the bulk sum and duration of our total bond investment outlay. Let us assume we have N10m in cash to invest, instead of one single lot investment of N10m, we split into 5 equal investments of N2m and place for 6, 7, 8, 9, and ten-year maturities. This means by the 5th year the first N2m will mature, if rates are higher, reinvest, if rates have fallen then reevaluate.
READ: 10 Side gigs to venture into while working a full-time job
What about Equities
Yes, equities also pay a dividend. In buying equities, we must ensure we are only buying stocks that pay a dividend above our huddle rate of 10% which is the 10-year FGN bond rate. Which Nigerian stock meet that huddle rate?
- Lasaco
- Zenith
- GT bank
- United cap
In closing, let us summarize. Retirement is not chronological age. The event occurs when our passive income pays our bills. Planning for retirement means planning to reduce obligation in the future by investing today. Investing in retirement is income-based with a huddle.
Financial Literacy
Steps to take to bag international scholarships
Here are the steps you should take if interested in pursuing international scholarships.
Studying abroad gives you exposure among many other things, and that is precisely why many Nigerians have been looking for ways to study abroad. However, not everybody is privileged with the resources to study overseas and this is where the international scholarship option comes in.
If you are interested in studying abroad and don’t have enough funds, you should consider applying for international scholarships. This article lists the steps you can take to bag international scholarships but before delving into that, here are some types of scholarships available to you as an international student:
- Location-based scholarships
- Course or program-based scholarships
- Sports-related scholarships
- Research-based scholarships
- University-funded scholarships
- Organization-funded scholarships
- Government-funded scholarships
Having discovered the types of international scholarships available to you, here are the steps you should take to bag any of these international scholarships.
Research: Research is vital if you don’t want to miss out on good opportunities or make mistakes during your application. Research scholarship opportunities available in your prospective college or location and be on the lookout for hidden scholarships.
Check your eligibility: Having done thorough research and discovered the available scholarship opportunities, check to see if you are eligible for them. Many international scholarships have their criteria and requirement, so you should confirm that you are the right fit first.
Get the required documents: After confirming your eligibility, you should get the necessary documents. If the scholarship requires you to write an exam, prepare for the exam, write a good statement of purpose and prepare all other documents.
Start your admission process: Some international scholarships require that you start your admission process and probably get the admission before starting your scholarship application.
Contact past scholarship winners: You might want to contact the previous scholarship winners to know what they did right and how you can learn from them.
Apply for the available scholarships: The last step is to apply to every available scholarship.
The best way to get funds for your undergraduate, postgraduate, or PhD pursuits abroad is by applying for international scholarships. If you do thorough research, you can find fully funded scholarships that won’t require you to pay any amount. One of the essential steps to getting an international scholarship as a Nigerian is staying abreast of current information and this will require you to network with others.
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