Index-tracking balances costs and returns in high-fee markets

Investors worldwide are grappling with high investment fees. For example, 34% of global investors surveyed in a recent bfinance Investors’ Costs and Fees poll say their fund servicing costs have increased in the past three years. Yusuf Wadee, Head of Exchange-Traded Products at Satrix*, shares insights on these fee trends and how index-tracking investment product providers balance cost-effectiveness and returns in this high-fee landscape:

“The industry is observing pressure on fees across all asset management sectors. However, index-tracking investment product providers balance cost-effectiveness with consistent performance to provide efficient, accessible, and value-driven index-tracking solutions that stand the test of time. This balance can help investors harness the full power of compounding returns while minimising the erosive effects of high fees.”

Yusuf Wadee

The Widespread Phenomenon of Global Fee Pressures

Ever-reducing asset management fees have become a global phenomenon affecting active management and rules-based investment strategies. Wadee notes, “The fee pressures are playing out almost everywhere in the industry. However, the driving forces behind this trend differ across investment disciplines.”

He says in the active management space, the trend of investment outflows has persisted. This exodus has intensified the downward pressure on fees in this market, particularly given the traditionally higher fee base associated with active management.

Conversely, the indexation space, which includes rules-based strategies, has experienced consistent inflows into our markets. “Here, the fee pressures among competing product providers are more related to players trying to capture more of the market and new inflows via aggressive fee positioning,” he explains.

The Compounding Effect of Fees on Returns

Understanding the long-term impact of fees is crucial for investors. Wadee draws a compelling parallel between the power of compounding returns and the eroding effect of compounded fees.

“Much has been written on the power of compounding. The fact that a simple (but consistent) investment strategy, involving investing early in the market and staying invested, yields profound results after many years is powerful. This is due to the effect of compounding – simply put, you get growth on your growth.”

However, he adds that this same principle works in reverse concerning fees. “The eroding effect of high fees works similarly – but in the opposite direction. The long-term impact of high fees consistently levied year after year on investment portfolios over time is also driven by the same compounding force – the only difference is that the compounding force of higher fees acts in the opposite direction to the compounding of being invested in the market.

Wadee says even minor differences in annual fees can significantly affect wealth accumulation over time.

Balancing Cost Reduction and Performance

In response to fee pressures, Wadee says Satrix has had the benefit of having the first mover advantage in the South African indexation market. As such Satrix has been able to reach, very early on, a significant scale of assets needed to effectively operate an indexation business in what is a very competitive market. “Past a certain scale, indexation firms can extract economies of scale and efficiency benefits that allow us to ensure performance and quality for our investment strategies despite market fee pressures.”

The Case for Index Tracking in a Challenging Investment Landscape

Wadee says index tracking offers significant value to investors in the evolving investment landscape, particularly in the current high-fee environment. For instance, Satrix research shows that in South Africa, almost 90% of active manager returns result from market performance, which they can track using simple, low-cost index tracker funds.

“This raises an important cost-benefit question for investors – how differentiated, consistent, and successful are actively managed funds’ returns versus how much investors are paying in fees to achieve those returns? The higher costs of active management compared to index tracking means that the median performing active fund almost always underperforms an index tracking fund on a net of fees basis.”

Minimising the Effects of Compounding Costs

Wadee emphasises that the impact of fees is less pronounced in index tracking than in active management, particularly over the long term. “The effect of higher costs compounds over the medium to long term and creates a significant headwind for active managers and investors to overcome. In contrast, index tracking’s lower fee structure allows investors to benefit more fully from market returns, minimising the erosive effect of fees on long-term wealth accumulation.”

He says for investors, the message is clear – while low fees are essential, they should consider them in the context of overall value, performance, and alignment with investment goals. “In an environment where every basis point counts, index-tracking investment product providers must strive to optimise their offerings and ensure investors can harness the full power of compounding returns, minimising the erosive effects of fees, and maximise long-term wealth creation potential,” concludes Wadee.

*Satrix is a division of Sanlam Investment Management

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