Do you choose investments same way you choose wine?
Fees do matter.
How do you choose a bottle of wine in a restaurant with a wide selection if you don’t know much about wine?
Chances are you will look at the prices of the cheapest bottles, compare it to the most expensive and choose a bottle somewhere in the middle of the range, arguing that it can’t be too bad. The same is probably true where
investors have limited knowledge about investment markets. How do you judge the value of a financial plan or investment fund if you don’t know much about personal finance or investments? There is a risk that one could look at the fees and decide that cheaper funds must be an indication of poor value while expensive funds must offer the best value.
The problem is not so much the fee itself (although it matters a lot), but about the difficulty in really trying to determine what value each person in the value chain is adding – the advisor, the discretionary fund manager (DFM), the platform, and the fund manager.
This is difficult enough at the best of times, and more problematic if you have to make a call while looking at total investment charges expressed as percentages. Moreover, the marketed “value add” could largely be a function of something outside the seller’s control – like the general market movement during the period.
A financial advisor recently took issue with what he referred to as the media’s incessant focus on fees. He says often the first thing new clients ask is: “what are your fees?”
While this is probably not the best question to put to an advisor as a starting point, it is an important question and advisors should not be unwilling to explain how their fee relates to the value they add to the investment process.
Arguably, the growing focus on investment fees over the past few years hasn’t largely been a result of media articles, but rather a result of low-cost index funds and exchange-traded funds (ETFs). There have also been increasing concerns from regulators about poor investment outcomes.
The poor performance the local market has experienced over the past few years has also put significant pressure on participants to demonstrate their value.
In an environment where pension funds were delivering returns above 10% per year after fees, no one really cared about the 1.8% odd they had to pay, but when returns are 5% or less and not keeping pace with inflation, losing a quarter of your growth to fees becomes a lot harder to take.
I recently witnessed an exchange between a financial advisor and a fund manager, where the former questioned why the manager hasn’t lowered his fees despite the relatively poor performance of the fund. The fund’s total expense ratio was 1.7%, while it delivered roughly 3.7% (after fees) over the past three years.
“My fees are under the spotlight,” the advisor said. “So should yours be.”
The fund manager didn’t have much to offer as consolation, but said they were trying to lower fees and that the general direction was down.
US firm Fidelity Investments’ recent decision to offer index funds at no cost has added a new dimension to the debate.
In South Africa, Sygnia’s decision to close its hedge fund products has also added impetus to questions around the value investors receive for the fees they pay.
Investment research suggests that if you want to tip the odds in your favour, ensure that you match the market and get costs out of the way.
A study previously conducted by Morningstar showed that funds with lower total expense ratios have a higher chance of succeeding against their category peers, both in terms of survival and outperformance.
This does not suggest that investors should only use fees as the guiding principle for investment decisions – it highlights the problem with arguing that a more expensive solution will deliver better returns.
Ultimately, the question is not which product is the cheapest but rather, what added value investors receive for the price they pay.
Everyone in the value chain should be able to justify their value add in relation to the fees they charge.