Published in Asia Asset Management March 2007
Fund managers in Singapore have expressed concern that the recently announced fee limits for new investments in Central Provident Fund Investment Scheme (CPFIS) products may result in some funds, which are performing well, pulling out of the CPFIS.
If this is indeed the case, it will leave investors not only with a smaller universe of funds from which to choose, but also options that are not the pick of the crop. “Lower expense ratios means that more complex, active and expensive funds are less likely to be made available for CPF investment,” observed Lindsay Mann, Regional Head, Asia, First State Investments.
“If fund managers were to decide that they can’t meet the guidelines then you basically end up with a much shorter list, and this may not include funds that are doing very, very well,” echoed Corinne Cheok, Director of Marketing at Aberdeen Asset Management Asia Limited.
“I think the caps are there to protect investors’ nest eggs but how will they affect the availability of products and the choices of CPF clients,” questioned Madeline Ho, Managing Director, Fidelity Investments (Singapore) Limited. “It all depends on what funds are ultimately included in the CPFIS,” she added.
Last December, the CPF Board announced that it would be implementing a cap on fee charges for new investments in funds that use CPF monies. Sales charges will no longer be allowed to exceed 3 per cent from July 1; while annual total expense ratios will be capped at between 0.65 and 1.95 per cent, depending on how risky the fund is, from January 1 next year.
Funds that are unable to meet these fee limits will not be permitted to take in new CPF monies. Investors who have already committed to these funds can either leave their money where they are or switch to other CPFIS funds, at no cost to them, within a stipulated time period.
CPF explained that the new rules were meant to help members build up their retirement savings faster. Sales charges and expense ratios erode investment returns, the board explained, adding that the sales charges and expense ratios of CPF funds were high compared to other markets.
According to CPF figures, sales charges and expense ratios on retail funds in Singapore are about 2.8 and 1.8 times that of the US respectively, a situation that industry observers attribute to the small size of the market.
“We don’t have a critical mass here, there are no economies of scale,” explained Giri Mudeliar, Executive Director of IMAS (Investment Management Association of Singapore), a representative body of investment managers, set up in 1997, to spearhead the development and growth of the fund management industry in the republic.
As it stands, 250 out of the 440 CPFIS-approved funds in operation as at the end of last September already meet the new fee cap criteria. The remaining 190 funds will require their managers to return to the drawing board for a candid review of the charging structure of the fund, and a hard look at whether it makes business sense for them to comply.
Where sales charges are concerned, distributors have already accepted the 3 per cent as a given, according to Mr Mudeliar. Although the industry standard for sales charges is about 5 per cent, distributors often offer discounts in practice and, for large enough sums of money, 3 per cent is not uncommon.
“Fee reductions have been used by distributors as a tactical move,” Ms Cheok pointed out. “But if the front end fees are capped at 3 per cent, I’m not sure how often distributors will cut this to get people in,” she added.
It’s not such a straightforward story where expense ratios are concerned. Expense ratios of different funds currently vary widely with some high risk funds going up to the region of 5 to 5.5 per cent. “I don’t expect these funds to come down to 1.95,” commented Mr Mudeliar.
Mr Mann agreed: “A product that is inherently expensive because of its investment strategy may not be able to adjust.”
Certain funds may need a higher expense ratio, e.g. emerging markets funds or global funds which require more research and whose associated costs tend to be higher than, say, a Singapore-based equity fund.
Besides the management fee, other items in the expense ratio like legal fees, audit fees and custodian fees may be difficult to reduce. “There will be some core expenses which cannot be cut beyond a certain percentage point,” observed Ms Ho.
“The obvious thing is to cut the management fee, but I don’t think this will be the most popular option,” said Ms Cheok. “Costs are rising and we still have to pay our distributors. Fee sharing with distributors remain cast in stone.”
“An aggressively high management fee for a high performing or scarce product can be trimmed but the fund management company may decide that this is not justifiable simply to satisfy the CPF requirements,” said Mr Mann.
It will also not be as easy to reduce expense ratios for offshore funds compared with local funds. “It would be hard to change some of the elements of foreign funds for the Singapore market,” said Ms Ho. “This same set of foreign offshore funds are sold in many other jurisdictions outside Singapore and there is a limit to what can be changed as they are somewhat standardised worldwide.”
Small Funds May Go
With the new fee caps, small funds may no longer be commercially viable to run, as some fixed costs tend to be defrayed across the asset base. “The fund manager could subsidise the expense ratio while it builds the fund size or a decision may be made to simply withdraw from the CPFIS,” said Mr Mann.
Funds without a critical mass will likely be closed down or consolidated, and existing customers persuaded to move to other funds. “We could return the money or offer a free switch,” said Ms Cheok.
Still, fund managers are trying their best to bring expense ratios down, according to Mr Mudeliar. IMAS has been in discussions with fund managers and the CPF Board. “I think the CPF Board has heard fund managers out well. This is a small step now. It will hurt a bit but the message is to trim expenses.
“My feeling is that in one to two years time, the expense ratio will be looked at again to see how it can be adjusted for the betterment of all. If everyone is closing down, something must be wrong.
“There is unison in thought. The investing public, the regulator and the fund managers are all on the same page. We all want better returns for the investor,” Mr Mudeliar emphasised.
Many fund managers may be struggling to see where they fit in to the new scheme of things but from their perspective there is ample motivation to satisfy the CPF’s new fee cap criteria.
As at end September last year, S$31 billion of CPF retirement savings had already been invested in CPFIS products, with another S$77 billion still available for investment under the scheme. “All fund managers love CPF money,” remarked Ms Cheok.
“Those who invest with CPF money are generally observed to be less fidgety. The money is stickier,” she explained. “You can’t touch it anyway, so if you are sitting on a 5 or 10 per cent loss you tend to just leave it there. So, this is taking a long term view.” And a long term view is what all fund managers like to encourage.
In addition, distributors are more inclined to take on a fund if it were CPF approved because in Singapore, where many people are asset-rich but cash-strapped, this opens up an additional pool of money for them. “For us, what makes a big difference is what makes a distributor take on a fund,” said Ms Cheok.
However, according to figures from a Lipper report on Singapore Fund Flows commissioned by IMAS, CPFIS funds saw a net outflow of S$131.7 million in the fourth quarter of last year, down substantially from the S$15.8 million increase registered the quarter before. CPFIS inflows as a percentage of total fund inflows remained fairly stable at about 8.6 per cent, while CPFIS outflows as a percentage of total outflows was 12.3 per cent.
But more than just reducing costs, fund managers stress the importance of investor education. “The focus for us as an industry should be on how to change investor habits, how people approach investment,” said Ms Cheok. “We need to educate people to think long term, not to think big time. There are no short cuts, no risk free way and there is a price to be paid for expert management,” she continued.
From an investment perspective, it is easy to lose track of the long term when one is caught in a short term situation. “Retirement planning is long term. We may know it subconsciously but we need to be reminded,” said Ms Ho.
Calling the new fee cap rules a band-aid solution, Mr Mann said that they would only limit the erosion of benefits by high expenses but investors would continue to make inappropriate investment decisions based on short-term views.
At the end of the day, the industry will either just have to cut their fees so that their funds fulfill the new fee caps criteria or stop taking CPF money. The question is whether the funds that are still standing in the CPFIS after the deadline will be able to offer investors the best choices for growing their retirement nest eggs.