There is an argument that suggests the best predictor of future performance is fees and expenses.
But I think this statement is a slightly skewed one.
What actually drives performance is risk – the theory is that the more risk you take, the greater level of performance you should benefit from over the longer term. And what drives risk is getting your asset allocation right.
This is the key driver of risk, and therefore return, in any portfolio.
We’ve done some work to dig deeper into this costs argument.
We focused on the mixed assets sectors, that is, Mixed Investment 0-35% Shares, Mixed Investment 20-60% Shares, Mixed Investment 40-85% Shares, and the Flexible Investment sector.
What we found was that, particularly over the longer term, the higher the fee that the manager had charged, the lower the performance.
Now, it’s important to note there are some outliers. But typically it was the case that the higher the fee, the lower the performance.
As fund managers, we have to be really humble.
Although we hope to get most things right, there are times we are going to be wrong.
There are going to be years when we underperform. Yet the only guarantee you have in fund management is that costs will detract from performance year after year.
It doesn’t matter whether it’s an index fund or an active one – you have to manage your costs.
This goes beyond the headline cost figure, but includes all the underlying costs as well. It’s so important to manage costs, and in particular, transaction costs, which I believe are probably the most overlooked costs in fund management.
The rise of passive
When you look at the fund universe, there’s just far too many funds out there.
The UK All Companies Investment Association universe currently has 255 funds. It makes it almost impossible to select the best manager unless you have significant resources.
One of the benefits of the growth of index funds is that it will weed out a lot of the closet trackers, and focus the market on truly active managers. It will also push down fees overall, which is clearly a good thing for investors.
It should also encourage managers to really articulate their overall performance.
I manage both a fund of index funds and also a fund of active funds. It can be frustrating when you’re sitting across the table from a manager and you ask them: “In what period will you underperform?”
The response is sometimes along the lines of “there is no period in which we’ll underperform” or “we have a robust portfolio ready for any type of market.”
Yet no manager performs well in all situations, as they will have to deal with particular risks or factors.
Anything that will help managers articulate when they are going to perform, and the environments where they may underperform, would benefit investors.
The prospect of fixed fees
Increasingly, there is a debate around fixed fees for financial planning services or for fixed platform charges. But what about fixed fees for asset management?
There is a challenge with introducing fixed fund management costs for smaller retail clients, as you wouldn’t want to price them out of particular funds.
A fixed fee might in some instances come in at £2,000 or even £5,000, which might be very difficult for some clients.
Yet I think there is definitely scope for fixed fees for larger clients, for example where there are segregated mandates in place. In those kind of scenarios and others, a fixed fee model could be the way the market eventually goes.
This article is based on a panel discussion which Justin Onuekwusi took part in at The Lang Cat's Deadx 2019 conference.