In this post we will focus on fees. Yes an invigorating subject matter, but no doubt one has to be very careful in the world of investments, if one does not want to be overpaying for things. And there is also some real ingenuity at work here and we get a fascinating insight into the mechanics of the financial services industry. Here are then some of the things every investor should pay very close attention to, so as not to pay unnecessary fees:
1. Foreign Exchange – I have stopped losing count of how many times one can get overcharged for doing nothing more than simply exchanging one currency for another. Currencies are traded over the counter (OTC), which means a bank is most likely your counterparty and not a centralised exchange (where everything is standardised). Make sure you understand all the fees specific to the institution you are dealing with. Look very carefully for implied or interpolated fees, such as spreads (Bid – Ask), commissions, minimum order charges, or transfer fees, even when moving positions between your own accounts. We once found that a EUR/USD forward was booked into our USD account, but on settlement we received Euros. We were charged a very costly F/X conversion we didn’t have to do (if we had booked the forward in the Euro account). Also, always check the executions and make sure the price corresponds to current market levels. Remember, no one trades for free (zero commissions), someone is always making money somewhere.
2. Executions – I still remember the day very vividly, and it shattered my belief that I had ‘seen it all’, even after 20 years in investment management. We were in the process of opening a managed account for our client with a very reputable European bank. When we came to negotiating the transaction fees for stocks and bonds, we were asked how much we wanted to keep for ourselves. I asked for clarification and was told that the broker typically charged the client up to 1.5% to execute a trade, but that as much as 1.4% went back to the asset manager. When I asked which of their managers would do such unconscionable things, I was told all of them. Now, this was 7 years ago and as much as it would seem that this couldn’t happen anymore in today’s more stringently regulated world, do check what the actual gross transaction fees are at the manager level. Also, ask how many times a year they rebalance your portfolio, as no matter what the transaction costs are they do add up.
3. Performance fees – There is nothing wrong with giving people an incentive to perform. Do we think the right number is 10% or 20% of our gains? Well, that would depend on what the strategy is expected to return and what the risks are. If a manager came to me with a 20-year track record of making 20% per year and had never lost money, I would be willing to pay them very generously. If, on the other hand, a manager came to me and the only way for them to make money was to get lucky (and the market has to go up), then I probably wouldn’t be inclined to pay them anything at all. Never pay a performance fee to anyone who is ‘long-only’ and make sure the reason someone is making money is because of some specific skill, technology or structural reason, other than simply taking market risk (which you can buy for as little as 0.10% in the form of index funds and there is no performance fee).
4. Paying for cash – This one is a little less obvious, but all the more interesting. If a manager came to you and said “I can reduce the risk of your investment by simply not investing half of it”, would you pay them a management fee on the half you didn’t invest? It would seem ludicrous, as we could simply just give him half of whatever we wanted to invest and keep the other half ourselves (and not pay a fee). But, so many investors do exactly that and pay managers to keep substantial levels of cash, paying fees of up to 1% and more. So do check the average cash level of your favourite strategy and don’t believe any argument they make, they cannot time the market and you are better off holding the cash yourself. There is never a reason to pay someone for doing nothing.
When I first started trading, my boss told me that investing is like walking down a dark alley in a big city. Everyone is out to get you and it is up to you to protect yourself. Knowing where to look and making sure your professional service providers know, that you know, what they know, can make a big impact on your bottom line. Reducing costs and fees can be one of the most rewarding exercises you will ever do. It is the gift that keeps on giving and you don’t pay for year after year.
Please also see our post: How Much Does It Really Cost to Make an Investment? where we explain the components of the Total Cost of Exposure Ratio (TCER).