The advice industry is encouraged to hold an increasingly binary view of costs: products are either expensive or cheap.
High costs are invariably bad, while low costs are always positive.
The message over the segmentation of costs and who is responsible for each part of the cost ‘pie’ appears poorly understood. However, I believe this view on costs is unhelpful in analysing the relative merits of different products and in delivering long-term value for clients.
You get what you pay for?
In fund management, the link between quality and costs is loose. It is not like buying an expensive watch, where there is a relationship between its longevity and accuracy, and its price.
There are still funds that charge active fees for benchmark-like performance. However, the answer is not to buy the lowest-cost product, but instead to ensure that fund managers are delivering value for the price they charge.
We would argue it can be worth paying for a higher-quality product. The new ‘value assessments’ required by the Financial Conduct Authority provide a useful insight into whether a fund has been worth its higher cost, but this is something we have done as part of our own analysis for years.
There are still funds that charge active fees for benchmark-like performanceIt is a similar picture with performance fees. These have become the bogeyman of the investment industry, and yet, structured correctly, can be an important tool to link performance and remuneration.
We paid performance fees on a number of our holdings in our Smith & Williamson MPS this year that had significantly outpaced their benchmarks and the wider market.
One of them was the BH Macro fund. The fund, which employs global macro and relative value trading strategies, rose 28.1 per cent in 2020 (source: company RNS, 27/1/21). Perhaps most importantly, it rose significantly at a time when markets were sliding: in the first quarter of 2020 it rose 23.04 per cent in net asset value terms. In March alone, it rose 18.3 per cent (source: company RNS, 23/4/21).
To our mind, the portfolio protection provided by this diversification justifies a higher ongoing charge (currently 2.3 per cent, which includes a performance fee of 0.3 per cent. Source: Morningstar/ICE as at 31.12.20)
Funds that employ more complex strategies, that have greater depth of analyst resources, that operate in less liquid or hard-to-access markets, will all have higher costs.
Yet these investments can bring new sources of uncorrelated returns. 2020 has shown the importance of this diversification. We believe it is likely to become even more important as investors navigate the complexities of the post-pandemic world.
Trading costs
This binary view on costs also tends to apply to turnover. The industry has worked hard to stamp out the bad habit of excessive trading. This used to be common practice as brokers sought to maximise their commissions and poorly disciplined fund managers were prone to churning their portfolios. The practices have rightly been exposed and – largely – eliminated.
However, it has left investors with a lingering mistrust of all turnover, even when it is necessary. 2020 was a good example. The world had fundamentally changed, fund managers needed to reassess the holdings in their portfolios in light of these changes.
Equally, as markets started to recover, it was clear that many investments had been sold off too far and fund managers could take advantage of low prices.
Turnover rates were higher for many active funds, but in most cases it led to better performance. Advisers may be concerned over a 0.2 per cent rise in transaction costs, not realising that it has contributed to significantly higher returns.
A better understanding
The way costs and charges are currently presented focuses on the negative. Charges are presented as a drag on investment, with no balancing statement of returns. Of course, investors can save a lot in fees investing in trackers, but they may be missing out on higher returns, diversification opportunities and better portfolio management.
We need to educate the industry about what these costs and charges really mean, and where they are receiving value. We find a widespread misconception that the wealth manager is responsible for all the costs. This ignores the role of the platform, which is often responsible for a higher share of overall costs than the wealth manager, and the fund manager, where focusing on low costs may be a false economy. There are areas where it is worth pushing back on costs, but in investment management, the lowest-cost solution may not always bring the best results for clients.
The post-pandemic world is likely to be more complex. Fixed income looks difficult, investors will have to navigate inflationary pressures and structural economic shifts have been accelerated. It will require skill to manage through this time. While we never underestimate the importance of keeping costs low, low-cost solutions alone may not provide the tools investors need for this new landscape.
Mickey Morrissey is head of distribution at Tilney Smith & Williamson
