Historically – and certainly over the past three years – investors have been too focused on low fees, argues Blue Sky Alternative Investments' Alexander McNab.
Industry super funds are marketing low fees as the ‘be all and end all’.
The Financial System Inquiry has kept that momentum going by pushing for lower fees on superannuation.
While fees are an important contributor to overall portfolio returns (which should be the objective for most investors, after all), low fees are just one element in the long-term performance of a super account.
The other is investment performance, and a holistic view of long-term performance as a function of fees and investment returns tells a very different story.
Rather than focusing on the average fees they pay across their entire portfolio, investors can achieve better results through a mix of high and low fee structures.
Getting the mix right
So when should investors look for low fees and when are higher fees worth it?
Most Australian portfolios have exposure to the listed equities market.
History and academic evidence suggest it is hard for investment managers to outperform in the equities space over time, and that the difference between a high-performing manager and a low-performing manager when it comes to equities is modest at most.
In this context, it rarely makes sense to pay active management fees for listed equities exposure.
If all you are getting is market returns (‘beta’) you might as well get it cheaply.
There is no point paying a high fee for a modest performance and modest returns.
The part of the portfolio that is generating beta should be built with low-cost, low-fee options (such as an index fund or a smart beta fund).
Many investors aspire to do better than market returns, looking for a bit of outperformance (‘alpha’).
Again, history would suggest that the best way to do this is not to look for a better Australian equities fund manager, but to allocate a part of their portfolio to different asset classes that can provide uncorrelated, outperforming return streams.
These asset classes include hedge funds, private equity and venture capital, private real estate and real assets, all falling within the category of alternative investing.
But with an alpha strategy, the dynamic changes: picking a good manager is much more important.
The difference between good managers and poor managers is wider, and these differences tend to persist over time.
Allocating to alternatives will mean a higher fee (because alternative strategies are more expensive to implement), but in general a high-performing investment manager will earn the fee – they will deliver performance that is genuinely differentiated.
Paying for outperformance
The most sophisticated investors around the world know that it is worth spending money on that part of the portfolio for extra returns.
US universities endowments like Harvard and Yale have allocated more than 50 per cent of their portfolios to alternative strategies, which has contributed to their outperforming the market over very long periods of time. So has the Future Fund in Australia.
Traditionally, access to these alternative strategies has been restricted to institutions and very wealthy individuals, but that is changing with the emergence of new products that can give smaller investors (and their SMSFs) exposure to the uncorrelated return streams provided by alternatives.
The industry needs to stop seeing fees as the be all and end all.
By focusing on overall fees, investors risk paying too much for some exposures (beta), not enough for others (alpha) and not allocating enough to the asset classes that can deliver real outperformance.
This seems like a pathway to mediocrity.
Alexander McNab is chief investment officer at Blue Sky Alternative Investments.
As artificial intelligence (AI) becomes the “future of everything”, savvy investors are heavily backing companies involved in this space...