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Understanding Investment Fees: Evaluating Their Impact on Your Investment Portfolio

Posted On:30th,Jun 2023

Catagory:Personal Finance

Understanding the impact of fees on your investment portfolio is crucial for every investor seeking to optimise their returns. While fees are a necessary aspect of investing, it is essential to grasp their significance in average returns and how they can affect your overall investment performance. By delving into the world of investment fees, investors can make informed decisions and prioritise their net return, the return after deducting fees and expenses. In this article, we will explore the importance of investment fees, the various types you may encounter, and how to balance the investment fees you pay.

Peter Lynch said: "Investing should be simple, and excessive fees only complicate matters. Focus on minimising costs and maximising your net return." 

Previously I wrote an article on how fees impact your investment returns over a lifetime. Included in the article were all the fees involved being deducted from your unit trust investment. 

A quick summary  

Management fee + Performance fee + Other fees (audit, custody, trustee, VAT) 

= Total Expense Ratio (TER)

Total Expense ratio + Transaction costs = 

Total Investment Charge (TIC)

There are two interesting facts I want to provide before we delve into the importance of net return. The first fact is that lower fees provide a higher degree of consistent outperformance and the second fact is that funds with higher fees on average do not display a higher ability to outperform.

Lower fees provide a much higher degree of consistency in outperformance: As can be seen from the image below. As the Total Investment Charge (TIC) increases, the funds' time above its sector average decreases. This means that the more you pay in investment fees the more likely you are to have below-average performance. 

Source: Prescient Investment Management

Funds with higher fees on average do not display a higher ability to outperform. In general, active managers charge more for their investment management services than their passive counterparts. This gives the perception that you are paying for better performance, but in reality, as per the chart below, you can see that on average as the TIC increases the funds' 5-year annualised returns decline as it becomes harder for the manager to recoup the fees.

Source: Prescient Investment Management

 

The Importance of Net Return

When assessing the performance of your investment portfolio, focusing solely on the gross return may not provide an accurate picture of your actual gains. It is the net return, the return after deducting fees and expenses (mentioned above) that truly reflects the growth of your investment. A higher gross return might seem appealing, but if it comes with substantial fees, your net return could be lower and your time above average will decrease as per the images provided above.

Examples: All figures are dated 31 May 2023 (ASISA MA High Equity Ave return 7.7%)

Hedge Funds:

TIC

5-year annualised performance

Peregrine High Growth Fund

7.85%

11.68%

Bateleur Long Short

3.2%

8.6%

Actively managed unit trust funds:

   

SIM Balanced Fund

1.56%

6.06%

Fairtree Balanced Fund

2.54%

12.98%

Passively managed unit trust funds:

   

Satrix Balanced Fund

0.61%

8.4%

Sygnia Skeleton Balanced Fund

0.52%

8.9%

All the TIC fees above can be found on their minimum disclosure documents (MDD) or by clicking on the links.

The table above shows that fees differ vastly between these funds. If we focused on fees alone then nobody would have chosen the two top performers, but past performance is not an indication of future performance. As you can see just by having lower fees such as the passively managed unit trust funds, provide above average returns at a really low cost. You want to avoid paying for underperformance as in the case of the SIM Balanced Fund in this scenario. Let's discuss how you can achieve a balanced investment fee portfolio. 

 

How to Create a Balanced Investment Fee Portfolio 

In this article, I discuss the Core and Explore (Core-Satellite) investment and all you need to know to benefit from this strategy. The important takeout for this article would be to create a core (70%) of low-cost index funds and blend it with active managers (30%) you have conviction in. This method places the statistics of successful investing on your side by having your fees dramatically reduced, your changes of time above-average increase, and your 5-year return increase. 

 

Summary

As an investor, it is essential to be mindful of the impact fees can have on your investment portfolio. While fees are a necessary part of the investment process, clients should prioritise evaluating the net return they receive. By understanding the different types of fees and their impact, investors can make informed decisions and select investment options that align with their financial goals. Remember, a thorough analysis of historical performance, time horizon, and risk profile should complement the evaluation of fees to achieve a well-balanced investment portfolio.

 

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