Talking fees with fund managers
It takes a particular type of nerd to be a fund manager. But while they usually care about doing the right thing by their clients, they have a business to run and that business has two metrics: funds under management (FUM) and the fee they skim from the FUM.
I always ask each fund manager what their fee is, and they’re always quite happy to tell me, but just in case they try to fudge it, I always go looking for it on their websites before the interview.
And guess what? It’s invariably hard to find. With most other products and services, such a subscription to Eureka Report for example, the price is front and centre. For petrol it’s even on a huge board out the front of the service station. If you go shopping for clothes or groceries, the price is on the garment or the shelf at the supermarket.
But with investment services, you have to go looking. It’s not exactly hidden but nor is it upfront. All sorts of qualities are promoted on the websites and brochures, such as the expertise of the manager, their ethical and social credentials and, of course, their performance.
These things are all important of course, but as I’ll explain they’re not as important as the price. So why isn’t the price revealed upfront, even by those who charge less than most? I’ve given this a lot of thought over the years, and concluded that they’re a bit ashamed of the fees, but also the fee is a contra-indicator of how good the service is.
What I mean is that investment is the only service I can think of that you can buy where not only is the price not a guide to quality, but it works the other way: the higher the fee, the worse the service – on average, because there are exceptions to every rule.
As a rule, the more you pay for a car, the better it is. Usually, the more expensive a restaurant, the better the food. And if you pay for business class when you’re flying, you get a big seat and real china.
The fact that this doesn’t work with investing has been shown in study after study, and is a big problem for fund managers because it displays a fundamental flaw in their business models.
In fact it’s already causing them problems through the rise of passive investing through Exchange Traded Funds (ETFs), which offer a market-performance for a low fee. These have been the fastest-growing sector of the investment world, for at least a decade, for the simple reason that people are catching on to the importance of fees.
But ETFs have a flaw in the fees as well: they might be low, but they are still percentages, and percentage fees compound along with returns, no matter how low they are. Even if the percentage is a few basis points, it gets really big over time.
That’s the main reason I joined InvestSMART in 2019: because the company had just decided to introduce capped fees for their portfolios. A fee that’s capped in dollars cannot compound over time – it stays the same no matter how big your balance grows.
Active fund manager fees are another level of return erosion altogether. The ones I interview charge an average of around 1.5%, sometimes quite a lot more, sometimes a bit less. Often they charge a “performance fee”, which is an extra fee – usually 15% or 20% - if they do better than a benchmark
Rather than just go by my random, anecdotal of interviewees, last year I did my own study of the fees and returns of the top 100 Australian fund managers.
There was absolutely no discernible correlation between fees and performance – if anything it was inverse. The higher the fee the worse the return. That makes sense if you think about it, because the fee comes out of the return.
Grattan Institute also did a study of fund managers and found much the same thing: that the best subsequent returns were provided by the funds with lowest fees- almost 1% better than the average return of all funds.
InvestSMART’s John Addis did one too, and found that 81% of funds underperform standard benchmarks over 10 years, that the fee for underperformance is 1.79%, on average, and the average underperformance is 2.12%.
But here’s what I think is the most important thing about fees: they are the only thing about your investing that you can fully control. You can’t control the return you get because it’s all in the future and resides with the roller coaster known as the market. Even the funds themselves say that past performance is no guide to future performance.
You can obviously control who you give your money to, and make sure it’s only to people you like and trust, but the personnel in advisory firms and fund managers change all the time. You might decide you like the cut of someone’s jib and give them your money, only to find that they move on next year.
That’s the other reason I joined InvestSMART - because CEO Ron Hodge and Chairman Paul Clitheroe had been around for a very long time and I know that they’re going nowhere.
Things change, of course, and anything can happen, but the culture they have created, encompassing Australia’s first capped fees for investment products, will go on.
The fee is the only thing about the service you’re getting that you can control – if you can find it in the small print, or get the fund manager to tell you without mumbling. He will tell you, of course, but only if you ask: it won’t be volunteered.
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