LONDON — Steven Nathan is on a mission. Ten years after the JSE’s top rated investment analyst swapped number crunching for a disruptive dream, his 10X is managing retirement funds worth R8bn on behalf of 150 companies. Nathan’s thesis is clear – SA asset managers might not operate a classical cartel, but their practice of “price clustering” has the same effect. The international practice of money managers dropping fees as their asset base grows has not been adopted in SA. As a result, the mushrooming of the savings industry has simply added to the profits of the managers – with SA investors paying among the highest fees on earth. Nathan is determined to disrupt this cosy arrangement. In this instructive interview, he explains how the 10X flywheel is starting to turn as the compounding impact of costs hits the consciousness of investors. Expect the momentum, and the 10X effect, to grow. – Alec Hogg

Well, it’s a warm welcome to Steven Nathan, who’s the founder and the head of 10X but Steve, our relationship goes back more than 20 years, when I was starting off in business radio and you were the top-rated analyst on the JSE. Those days I thought you’d be moving onto Lamborghinis, and Ferraris, and New York, and perhaps London. But you took a completely different route in your career. You almost ensued all those riches and decided to follow a higher purpose. There has to have been some kind of a thought process that got you on that line.

Yes Alec, as you say, in those days, (in the 1990’s), one of the things I did was an insurance analyst. I was a life insurance analyst and I got to understand the inner-workings of the life insurance industry and the asset management industry, and it was a big eye-opener from what we learn at university or in the CFA course about how we should manage people’s’ money in the long-term, as a profession versus when you get into the actual industry in the real world, and we see how to commercialise. So, a lot of salesmanship and not that much stewardship.

As you say also, I did enjoy the benefits of the investment banking industry and I also spent some time in London with Deutsche Bank, where I ran the global bank’s team, for Deutsche. I got to see some good practices but also, some not so good practices. I was also introduced to Index Funds when I spent time offshore and to Vanguard and to John Bogle. I just felt that I had this knowledge and this experience and I could use it to benefit a lot of investors. Rather than just trying to make all the riches myself.

I was disappointed to see the lack of competition and the lack of really caring about the ultimate investor. It’s very hard to differentiate any of the life companies in terms of the product. So, there was that experience and, also in particular my mother. She asked me for some advice on her retirement fund and when I saw what had been done over there and I decided no, enough is enough. Let me try and make a difference to benefit lots of people and to start a company that actually, people can trust and it’s a nice cliché because everyone says that – we’re all trying to get trust.

The problem in the industry is that there is so much complexity and choice. When we spoke in the 1990’s there was probably about 30 – 40-unit trusts. Today there’s over 1500 so, it’s getting more and more complex. More and more expensive and, as a consequence, people are getting less and less value for their long-term savings.

But what sparked you going back to Cape Town and starting 10X?

Well as I said, when I was overseas I got to see and got closer to the investment banking giants and I must say, I wasn’t particularly motivated to be part of that culture. I also, interestingly, I read a couple of books when I was there. One was Charles Schwab how Schwab disrupted the big brokers in the US with the deregulation of commission and he became an investor champion by offering a direct, low-cost brokerage. I also read, interestingly, Michael Dell, ‘Direct from Dell.’ It was round about 1987, when he was at university and he started selling computers. He has a quote in the book, which I’ll never forget and he said, “The PC industry in the 1980’s was the marriage of the unknowing buyer and unknowledgeable seller.”

When I read that it resonated really strongly with me because I think the very same happens in the investment industry. The buyer just doesn’t know. They just don’t have the knowledge, they’re not empowered to know, and the seller, often the intermediary, just knows a little bit more and just knows the terminology and he’s able to win them over. I thought that was a challenge that I’d like to take up in the investment industry.

10X the start – the founding thereof, when was that?

I was in London in 2004, and I left. I came back to SA for one more year at Deutsche, and then in 2005, I left and part of the change was to move to CT because I had a dream of starting my own company and, also living in CT. Interestingly, when I started 10X, my first focus was on the individual client so, I thought ‘let’s have a direct to consumer business, focussing on the individual market.’ But if we rewind our minds back to 2004, I don’t even think Facebook was around, they were in 2005.

The more work that I did on 10X, trying to get the company going, looking at how we distribute the product. I realised that it was too premature. The market wasn’t ready and it would be really expensive to get a direct to consumer business because one of the sayings in the investment industry and the life insurance industry is that, ‘These are products that are sold and not bought,’ so people don’t walk into the big life companies and say, “Please, I’d love to buy a RA.” So, you have 10’s of 1000’s of intermediaries pedalling the streets and phoning people and actually selling them product.

That is the challenge that we faced in 2005/2006, and we were looking at structuring 10X as, ‘How do we actually get the product to the ultimate investor?’ Because sadly, in investing, a lot of good products sit on the shelves and a lot of bad products sell incredibly well. That was the challenge and then when I looked at that I said, “No, let’s rather go into the corporate/company market because if you can get one company with say 200 people then that is equivalent to 200 individual sales.”

We started off in the corporate market, direct to corporates to build some critical mass over there and then we started selling individual products a little later because I think the big thing with 10X is that we prefer to go direct to the client so, we’re not paying commissions to advisors or to intermediaries, and advisors therefore, aren’t incentivised to sell our product.

Who was the first company?

The first company was called Engineering Supplies. It was just through a friend. It was their company. I think they had about 80 people but it was interesting that our first presentation to them took about 3 or 4 hours. We had so much to say. I think we actually bored them to death and we had a break in between but it certainly wasn’t a slick presentation at all. Yes, Engineering Supplies – they were our first company. That was in 2008 so, we took about 2½ years, which is a long time to clarify the product, to do all the work we needed on setting up the investment portfolios, the legal entities, the trustees, the systems, the administration because we decided to do the administration ourselves. I think that’s quite an interesting point.

If you look at the corporate pension market – the lucrative side is in the asset management and the high risk and low-margin side is in the administration but most employees, people that are on a company pension fund, their key interaction with their pension or Provident Fund is the actual administration side, the benefit statements they get and the reports they get. In SA, what is remarkable still to this day is that outside of 10X no other retirement funded administrator discloses all the fees that you charge.

So, if you look at what they call a ‘benefit statement’ you just see a net return so, you don’t know what the portfolio return was, less all the asset management fees, the international fees, the performance fees, and platform fees, etcetera. At 10X I decided that we’re going to make things simple and transparent. We couldn’t outsource administration because no one could do it for us so, we also had to build an administration capability in-house and that took a little bit longer than we anticipated.

Steve, are Engineering Supplies still a client?

They are.

How much have you saved for them over the years, just in costs?

We more than halved their total costs and the saving is around about 1.5% of assets so, that company has about, at this stage, it will be about R25m of assets so, 1.5% would be, let’s call that R35 000, am I right? It’s actually, R350 000 per year over 10 years. They probably got, and just rough numbers, 1.5% over 10 years – probably about 20% more than they would have had. So, it’s R5m – R6m more.

Incredibly, on a R25m fund so when you start compounding the costs and that’s what Warren Buffett, and I know we’ve been to Omaha together, but Warren Buffett talks the same game, doesn’t he? Just focus on the cost. Get the cost down and actually, over time the miracle of compound interest makes a huge difference.

Without a doubt and one of the things that surprised me, and I’ve worked with numbers for many years, is when I was a life insurance analyst, and even when I was at university – I remember the life companies talking about these protected values that in an inflation environment you can expect your portfolio to return 15% per year. When you compounded that amount over 30 – 40 years, you thought you were going to be a multi-millionaire.

I remember thinking well, all I have to do is just buy one of these life company policies and I’m going to be set for life, and I never thought how it would work. When I became an analyst, I looked at it a lot more. When I started 10X, and I did a calculation in 2005, and I calculated that over the last 40 years a high equity balance portfolio produced about 15%. It was remarkably accurate. Over 40 years your average return was 15%.

However, inflation over that period was about 10% so, your return after inflation or your real return was only 5%. The projected values from the life companies never disclosed fees so, they never took account of fees. So, if you reduced your 5% return, after inflation, by fees, which could easily be 3% – 4%, is that what you find is that after 30 or 40 years, save intelligently, you’re basically getting your money back adjusted for inflation. So, there’s very little, real growth and real wealth creation. When I did those numbers I realised how important these small numbers become, these ½% or these 1%’s – how then compound over time. To really make or break your long-term savings.

I was looking the other day at the ETF portfolios, which clearly are offering a far better deal than traditionally, actively managed portfolios, in terms of costs. Even though they’ve outperformed active portfolios they’re still only about 5% of the industry, of the savings industry. I might even be exaggerating that somewhat. It seems in SA, it’s just taking a long time for people to click to this. Do you know why?

You’re right. Just on that number – if you look at the 2 biggest ETFs in SA they are the Gold and Platinum ETF, which is not really an equity type investment. If you strip that out the percentages of ETFs it is probably about 2% of our market, which is pitiful, as you say, compared to the likes of the US where obviously, ETFs are incredibly strong. And passive funds – I think it’s about 30% of the overall market and 100% of the flow so, what you see globally, is that money is moving out active into index, and we’re not seeing that in SA.

I think the reason here is firstly, ETF and Index Funds are behind where they are in the US. I mean Vanguard was started in 1974, and they launched the first Index Fund in 1976 and, it’s quite interesting if you read the Vanguard story. I remember reading it and one of the things that John Bogle said, is that when they launched the first Index Fund it was branded as un-American, who wants to be average. So, they took a lot of flak on it and for 60 consecutive months money flowed out the door.

So, Bogle and his team walked into Vanguard and money went the other way because people didn’t support the low-cost Index Funds. It took them a few decades to get that going and now it’s become the obvious way to invest. I think in SA, index funds, ETS, have only become prominent probably in the last, maybe 3 – 5 years. Secondly, and probably more importantly, is that investors in SA are still investing through intermediaries. We don’t have a self-directed or direct investment culture. Whereas in the US they do have that.

I mentioned Schwab a while ago, and Schwab they were very prominent in self-directed investing. They made it really easy and at low cost for people to take charge of their own finances. So, we don’t have that self-directed culture. We’re obviously seeing the online brokers gaining prominence but I still think they are quite small overall. Then also, the media have a role to play. I remember an international journalist, when I asked him what is the big reason between the success of Index Funds in the US versus the UK, which is also quite far behind the US?

This journalist said that, “Well, if you look in the US, they no longer glorify fund managers.” He said, “If you look at the Wall Street Journal and those kinds of publications, they don’t highlight the top performing money fund of the year or the manager of the year, or whatever it might be.” Whereas, I think in SA we still have a culture where fund managers are glorified. As I said, there are 1500 different funds at any one time, 10% or 150 of them are doing really well. They tend to be marketed and written about a lot. Our emotions are that we all want to be winners so, we all want to invest in those funds. I think we tend to chase performance. So, I think it’s a combination of those factors that mean that Index Funds and ETFs are still very small in SA at the moment.

Maybe what one needs to do is send every financial journalist in the UK and SA, a copy of, ‘Fooled by Randomness’ – Nassim Taleb will quickly disabuse them of that notion that these guys can keep outperforming. It’s an interesting point and you’ve got a piece that you’ve written and it’s on the 10X website, looking at Coronation, because it is a listed asset manager but to contrast how, with the success or the growth of an asset management business it can make superior returns if there’s no adjusting of the price that they’re charging to investors. In other words, what you call price clustering. Just take us through that model and perhaps contrast it to examples around the world, where price clustering does not happen?

Yes, I think that the point that we want to make is that if you look at the funds management industry, is the growth thereof. The growth has been tremendous in SA. It’s an incredibly large industry and the assets under management have grown well ahead of GDP over the last 10, 20, and 30 years. It’s an enormous industry and our concern is that the benefits of scale – the benefit of an industry, going well past critical mass. There’s been almost no benefit that the consumer has enjoyed from that. That goes against a classic economic theory that says, ‘For example, if you have the corner-store/café then you’re going to pay a much higher price than if you go to Shoprite that has enormous scale.’

If you look at the asset management industry, I mean Coronation has been an incredibly successful asset manager that had periods of really good performance in some of their funds. If my memory serves me correctly, I think they started in 1992. I remember, when I was at Deutsche, they had only a few billion of assets in the 1990’s. They were managing money for Sage. I think they had about 4 or 5 billion. But if you look at their retail funds, the unit trusts, when they started they were charging roughly 1.5% – it would have been the expense ratio when they had a few billion. Today they’ve got over 600 billion and they’re still charging the same, roughly 1.5% expense ratio so, it doesn’t seem as if these assets managers are competing on price or they are giving any benefit to the client.

Whereas if you look at Vanguard. When Vanguard started in 1974, what they’ve done every year is they had passed on any cost benefits to their clients so, I don’t recall the exact numbers but I think in 1974 their expense ratio was something like 0.84% and it’s dropped now to something like about 0.17% overall. So, over a period of 40 years you’ve had a dramatic reduction in benefits and that’s actually caused a positive virtuous circle is that as Vanguard has grown, they passed on benefits to their clients. They’ve become more cost competitive therefore more attractive and they’ve got more clients.

That has grown their business and globally, they talk about the Vanguard effect, where Vanguard’s cost model forces the industry to reduce fees, and with Vanguard recently entering the UK – there’s been a lot of publicity about the Vanguard effect and how that would reduce the cost for investors. So, a broad pool of investors can benefit from that but in SA we just haven’t seen that and that is a concern for us.

Also, what’s interesting, if you look at National Treasury in their Retirement Fund Reform – a couple of years ago they had a paper out on charges, the cost of retirement funds where they highlighted that SA was one of the most expensive countries, in terms of fees that people pay for their retirement funds. They had a comment, which sounded contentious and odd but they said that, “The SA retirement fund industry lacks competition.” By that they said, “They don’t mean there aren’t a lot of players. There are a lot of companies but it lacks competition because a competitive market would be one where the consumer/client can actually, see what they are paying and what they’re getting.” Basically, they said, “They can’t see what they’re paying because fees aren’t transparent and it’s very hard to measure your performance to see whether you are getting good value or not.”

So, this whole idea of almost subconscious price clustering – it’s a Cartel by another word. They aren’t sitting in a room and saying, ‘let’s keep our prices up’ and ‘let’s not pass on the benefits to the customer.’ But by nobody breaking with the norm, or very few people breaking with the norm, they can continue to go ‘business as usual’ and presumably, just pay their people more or pay their shareholders more. How does it work?

Yes, that’s right. I think you’ve got two sides of it. The one side is you’d say so, we have the price maker and the price maker in the investment is not the client. The price maker is very much the asset manager or the product provider so, they can make the price. As you say, they tend to all make similar prices, that is what I mentioned earlier. What really surprised me about the industry, if you look at the retirement fund industry and you could almost say the asset management industry – it’s hard to differentiate. If anyone can tell me the difference between Old Mutual, Liberty, Momentum, and Sanlam – it’s very hard to know what they stand for, as an investor.

Whereas, if you go to Woolworths versus Pick ‘n Pay, and versus Shoprite – you more or less, know the price, and value, and the quality of what you’re getting. There’s very little differentiation. Hence, they don’t compete on price, the asset managers, and the life companies. The consumer is a price taker because they don’t understand fees. Fees still aren’t transparent so, most people have got no idea of the fees that they are paying. Because they’re not empowered and it’s not transparent, they’re not making a price. It hasn’t become a competitive industry, in that sense.

I think, Alec, what’s also really, important here is that there are many fees so the fees – if you look at Coronation, for example, or an asset manager, any of the asset managers like Allen Grey. What we tend to focus on is just the fund fee so, what is the portfolio management fee, the investment performance fee? We look at that fee and that fee, for most of these companies if you look at their funds, they’re ranging between 1% at the lower-end and 2.5% – 3% at the high-end. The midpoint is around about 2%.

But there’s many other fees that an investor pays so, about 70% of South African’s at least, are using a financial advisor so, they pay an advice fee and that would be up to another 1%. Then many advisors recommend multiple portfolios so they say, “Well, don’t just invest with Allan Grey because that’s too risky. Let’s put half or a quarter with Allan Gray, Coronation, and Investec.” Now, let’s put those together and then you have to manage that administration. People don’t think about this but it’s not easy to manage the records of different asset managers so, they put you on a list platform and the investor pays, again themselves another 0.5% of assets for that.

It’s a very interesting dynamic, where the investors are actually paying for all the services themselves that the industry should be providing you. You pay separately for advice. You pay separately for admiration, and you pay separately for asset management and I would estimate that well over 90% of people don’t know the true cost of all of those fees that they’re paying. They are definitely price takers and not price makers.

Which would suggest that the industry is ripe for disruption?

Yes, I think if you look at it logically, you would say that it’s pretty easy to identify a better product so, at 10X for example. When I started 10X we had one objective. We said, ‘blank piece of paper – what we want to do is we want to have one portfolio or one strategy that every investor can invest in.’ Not a choice of 2, or 3, or 4, because if you have more than one, then you get different outcomes. So, if I offer you two portfolios and they differ by 2% per year. Over 40 years one is going be worth double or half the other.

That isn’t what we’re trying to do at 10X. We want to have a portfolio, a single strategy where everyone gets the best possible outcome, using foresight and not hindsight. So, before the time, what do we think that best, single investment strategy is? That’s what we do at 10X so, everyone gets that long-term strategy. It differs if you’re getting close to retirement and needing your money then the portfolio adjusts to account for that but most people are in the long-term portfolio but it’s one outcome.

Whereas, if you look, as I said earlier, in the industry there’s more than 1500 different options so, 10X’s single outcome has delivered very competitive returns since inception so, for almost over 10 years, when we measure ourselves against the large retirement fund managers in the Alexander Forbes Survey, before fees, we actually are slightly ahead of the average large fund manager. So, before fees we’ve delivered very competitive returns and if you take the fees savings then it’s even more competitive.

Objectively speaking you’d say, ‘Well that’s a really good portfolio. I don’t know which one of the 1500 are going to do well, I should go for a portfolio that has 10X’s characteristics.’ It doesn’t have to be 10X but it could be anyone else that has a sensible, low-cost fund but people don’t proactively invest themselves so, what we find is that they go to big, trusted brands and they use advisors and they just invest with a brand that they’re comfortable, and they actually have no idea what the underlying product or the underlying fee structure is.

While there is potential to disrupt the market it’s quite a hard one because you’ve got to break perception and, also, it’s quite a low-interest category. Most people don’t really think about their long-term savings early on in life. They tend to think about it probably in their 50’s, and they tend to look at how well they’re doing or how badly they’re doing and take action when it’s far too late.

I think it’s a challenge for all companies that are trying to simplify and reduce the cost of investing. It’s a challenge – how do you get a good product to the customer, cost effectively? I think that’s what you see with some of these ETFs. Is that an ETF on its own is a good product but once you add in the administration fee and the advisor fee and this fee and that fee, you can quite quickly take a good product and make it a bad product.

How’s it gone in those 10 years? What’s the market’s reaction being to you?

It’s gone well for us. We’re managing now in excess of R8bn. We look after about 150 companies so, it’s gone well but we think it should have gone a lot better. I think it has been a challenge and as I said, it’s really because people aren’t empowered. In fact, and it’s quite interesting. One of the companies I saw about 6 years ago, when I went to talk about what we’re doing, about the low-cost index fund and just taking the market at a low cost. Not trying to be cleverer than anyone else. How is that a better strategy? The MD of that company said to me, “It can’t be true what you’re telling me. If it was that easy then X, Y, and Z (my current provider) a big life company they would be doing this for me.” It actually was quite a tense meeting. Where I was saying that this is a fact. ‘It’s not my opinion but it’s a fact.’

Anyway, I never got the client 6 years ago but they phoned me up last week to say, ‘They would now like to move to 10X because they’ve seen that what we said 6 years ago actually, seems to be correct.’ I think it really is a challenge about getting people to have their confidence and their interest to take charge of their own destiny. What we see is so many people, for whatever reason, it’s either they’re intimidated. It seems too complex or they’re using a trusted advisor – it’s difficult for them to make their own decisions.

It hasn’t been easy because the industry has fought back, as you would expect. This is a competitive commercial market so, we’ve been subject to lots of rumours and innuendos along the way. When a company wants to move to us, there certainly have been some dirty tactics about 10X is too small or they’re not financially strong, or anything like that. I think it has been a challenge but, as I say, overall, we’ve done well. The momentum is growing and I think that’s important if you look at the trends that we’re experiencing, we’re actually growing very strongly at the moment and I think a lot of it is the increased media awareness. Slowly people are becoming more informed and more confident of making their own decisions.

Steven Nathan is the founder and chief executive of 10X.

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