Are your clients paying too much for fund management?
12 March 2014
Jonathan Faurie
Jonathan Faurie, FAnews Journalist
Clarity and objectivism are two of the key areas that the Financial Services Board (FSB) hopes to address with the development of the Retail Distribution Review (RDR). Clarity will rest with the consumer where he/she will know and understand the dynamics of how an adviser's fee will be calculated. Objectivism will rest with the advisers where they will have to give objective advice to policyholders because they now have clarity on how their fees are calculated.
However, there are still a number of policyholders who do not understand the dynamics of how their fees are currently being calculated, particularly the fees that fund managers charge when managing a retirement portfolio.
Deslin Naidoo, Head of Investment Research at Alexander Forbes points out that designing investment strategies for retirement funds rely on complex modelling of potential future liabilities and then matching them with appropriate assets based on long term growth expectations and an assumed risk tolerance for the fund.
"Implementing the fund strategy usually requires a layer of fees, from administration to governance to reporting, and of course the asset management fee. All of these fees are subject to market dynamics and competitive economic pricing," says Naidoo.
Advisers that want to build up a relationship with a client that is based on trust will as far as possible clarify the issue of fees. Naidoo points out that key to this, is adhering to three basic principles - don't pay more than you get, don't be fooled by randomness and eat off the same plate - when making the selection of a fund and a fund manager that will achieve maximum returns for the policyholder.
Don't pay more than what you get
Basic economic principles suggest that a consumer should never pay more than what he gets. It is these principles that establish the basis of the concept of 'fair trade'.
However, there are dynamics within the fund management industry which do not always adhere to this, and Naidoo warns that advisers must tread carefully when approaching this subject. "It would be counterintuitive to pay for something and then be told that not only are you receiving nothing in return, but you are going to have to pay more. Yet, this is exactly what happens with active managers. The investment manager promises you a certain type of additional performance where the performance target is to beat the market by 2%. It sets an expectation that the policyholder is purchasing a strategy that will beat the identified market benchmark by 2%. Unfortunately for the policyholder, when the fund does not do that, the cost increases," says Naidoo.
He adds that it would be short sighted not to recognise that a manager will have periods of underperformance. In an ideal world, it would be convenient to simply access this additional performance being sold by the manager without having to incur the downside of poor performance.
A key aspect of this principle is understanding the relationship between the risk that a fund manager takes and the reward that he receives by taking that risk. "If one takes more absolute risk in the portfolio, then one should be rewarded with greater return. Absolute risk is the total risk that the investment portfolio is exposed to. Relative risk is the difference in the structure of risk in the portfolio relative to the risk in the benchmark. If one takes more relative risk in the portfolio, then one will generate returns more varied than the benchmark," says Naidoo.
Don't be fooled by randomness
Investing is not an exact science. However, there are a number of principles and dynamics which influence the performance of shares and which shares would be considered safe investments.
However, from time to time, a fund manager's intuition - which is sometimes driven by nothing more than a gut feeling - can generate a desired result. To base your whole investment strategy on these feelings is dangerous as it is based on an act of randomness.
"Let's say that you are targeting a return of 3.5% on an investment. There is a 50% probability of achieving a positive outcome (> 0%) on a random basis over one year. Further to this, approximately one in five managers, 19.08%, will randomly deliver a return in excess of 3.5%," says Naidoo.
Basing your assumptions on solid principles, historical data and trusted market research will generate more long term success and should be the favoured model of advice.
You need to eat off the same plate
In order to achieve maximum results, Naidoo suggests that advisers and policyholders need to have the same investment mind set and be absolutely clear when it comes to targeted returns.
"Investment management, at its heart, is built on trust and the belief that the manager acts in the best interest of his/her client at all times. There is therefore little point in transferring all of the relative risk to the investor and the majority of the benefit accruing to the manager," says Naidoo.
He adds that in the article: Are active management fees too high? which was written by Richard Ennis, Ennis alludes to the fact that the higher the fee of a manager, the more certainty is required to validate that the manager can add value above his fee level. This implies that advisers who define investment strategies for funds or individuals need to be very cognisant of the associated cost structure. This must be factored into any process used for selecting the most appropriate investment managers for a strategy.
"The challenge for manager fees is establishing whether the manager generates skilful, or random outcomes. To determine this, you would need to analyse a robust fund strategy and manager research framework; using both qualitative and quantitative metrics. One would need more information, insight and transparency from a manager with higher fees as there is a greater risk of being incorrect in the assessment," says Naidoo.
Don't lose sight of the ultimate objective
Taking three principles into account is a very basic analysis strategy that advisers can adopt when selecting the appropriate fund and fund manager for a policyholder. But they are important questions to ask in order to establish a relationship with a policyholder that is built on trust.
"A fund or investor should have a very clear understanding of their investment strategy. The return expectations need to be clearly understood relative to the objective. Simultaneously, the return expectations need to be consistent with the risk to be assumed. Some funds would have a risk budget incorporated into their investment policy statements, which would provide more defined guidelines for this," concludes Naidoo.
Editor's Thoughts:
This has a lot to do with the passive vs aggressive argument. Advisers need to understand their client needs and the dynamics which are driving the investment environment. How easy is this when clients are expecting high returns in a passive market? Please comment below, interact with us on Twitter at
@fanews_online or email me your thoughts
jonathan@fanews.co.za.
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Comments
Added by Thomas, 12 Mar 2014Truth is..what do we as fin advisors do regarding a investment after it has been concluded. After we have selected the proper product for the specific need, risk profile analysis ,and investment placed and yes not least have carefully looked all underlying costs and compared these.
Should circumstances change ,yes, need to replan and consider appropriateness of investment but if there are no real changes..what do we do for our fees?.We cannot chop and change as soon as we feel markets change (timing).We have very little or no input after investment have been concluded? We all know that investments need time.
Should we take ongoing fees after initial fee we do then by default accept some responsibility..true or false?.What are we supposed to do for these ongoing fees?.This is only one side of the coin--the investment company have their own platform, admin and management fee structure for which they deliver a ongoing service. If a investor /client has been properly informed and correctly advised we as fin advisors jobs has been done . If we as advisors do take fees and things go wrong what do we say?
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