THE GRAVY TRAIN CAN HIT
AUSTRALIAN INVESTORS HARD

They may also encounter exit fees and switching fees.

The investors will no doubt also incur incidental expenses for postage, telephones, bank fees and so on, not to mention optional extras such as investment periodicals, Internet access fees, fax charges and courier fees.

It needs to be remembered that notwithstanding all this outlay half of all managed funds perform below the average.

Whether they realise it or not, investors collectively are also funding the whole system behind the scenes - the official regulators (Australian Securities and Investments Commission and Australian Prudential Regulation Authority), the privately run Australian Stock Exchange, the various share registries, and so on. The fees charged by these bodies and mainly passed on to investors indirectly are partly "user pay" and partly quasi-taxes or commercial profit margins.

Another negative feature for investors arises when fees are levied not on profitability (income or growth each year) but rather on the value of assets. Fund managers are thus rewarded even if the wealth of their clients has actually decreased. Fund managers can also enjoy unjust enrichment when asset values rise merely because of inflation or market booms.

It should also be noted that the commission system creates an inherent conflict of interest. It encourages an intermediary to recommend an investment which benefits the intermediary rather than the client.

The government's solution to all this - the compulsory disclosure to clients of commission - while better than nothing does not go nearly far enough. For example, intermediaries when selling superannuation rarely alert their clients to the existence of low-fee industry funds, as these do not pay commission.

PROFIT SHARING

Some managed funds have a system of incentive fees. Such an approach has obvious advantages for their investors, provided that the incentives are not too generous - especially in relation to performance measured in dollar terms to the extent that it is virtually automatic as a result of inflation rather than due to the skill of the manager.

The period over which performance is measured can also have some relevance. For example, a fund with a mediocre performance over a whole year may have had three poor quarters and one excellent quarter. To pay an incentive fee based on the performance in the latter without regard to the former may not really be warranted even though the rules of the fund may allow this.

The existence of an incentive formula on these lines may even be counterproductive as far as the investors are concerned, as it can encourage a fund manager to seek out the more speculative investment situations in the hope of boosting short term results.

Some funds involve a profit-sharing formula, so that 20 per cent or thereabouts of performance above a certain threshold goes to the manager. However, such an approach:

CAPITAL GAINS TAX

In some cases investors in managed funds can incur double capital gains tax resulting from the one transaction - one lot levied within the fund when an asset is quit and another on their own account when they dispose of their units.

Furthermore, investors in managed funds have no control over the actions of the fund manager in disposing of trust assets. They can thus find some of their dollars flowing to the tax office in circumstances when this would not have occurred in the case of equivalent assets controlled by them directly.

SOME ADDITIONAL COMMENTS REGARDING SUPERANNUATION

Under the superannuation guarantee legislation employers have to pay contributions into a superannuation fund for their employees. The current rate of contributions is 9 per cent of salaries or wages.

Other things being equal, the level of fees can make a significant difference to the eventual retirement benefit, as the following illustration shows:

The first figure represents 6.53 times final salary - a reasonable retirement benefit at age 65 after long service. The second figure represents only 3.37 times final salary.

SUPERANNUATION TAXES ADD TO THE PROBLEM

The Federal government says that it wants to encourage saving for retirement. However, it imposes a number of taxes on superannuation:

CAPITAL SECURE AND BALANCED MANAGED FUNDS

As pointed out in Understanding the Stock Exchange money can be placed on term deposit with a bank or some other institution without any initial fees being incurred. It thus makes little sense for investors to incur heavy charges for placing money in a so-called capital secure managed fund which proposes to invest in fixed interest paper offering similar returns and security.

These comments apply equally to the fixed interest components of balanced funds.

Instead of putting, say, $20,000 into a balanced fund which is aiming at 50/50 income and growth, an investor would be better off arranging the 50/50 split in person by: