Finance

Crouching Fees, Hidden Loss

When you subscribe to a fund, there are almost always small fees associated to your investment. Such fees could be subscription/redemption fees (when entering and exiting a fund), transaction fees, management fees, performance fees, operating costs, etc… These fees seemingly small can have a significant impact over time on your investment. Not only do you lose on paying those fees, but more importantly you lose the potential profit you would have made by investing those fees!

Let’s take an example and see how management fees and performance fees can affect an investment portfolio over 10 years. As a demonstration, we will build a portfolio comprised of a 100 stocks from the Nasdaq 100 Index. We could obviously take any other example, but be sure to take a portfolio with positive results to measure the impact of performance fees.

Here below are the main parameters of our portfolio :

  • Stocks: the current components of the Nasdaq 100 Index.
  • Initial Capital : 100 000 USD.
  • Start date : January 1st 2010.
  • Management fees : 1% ; paid quarterly.
  • Performance fees : 20% ; paid annualy; Perpetual annual high-water-mark.

The true impact for investors

  • In 10 years, without any management and performance fees, the portfolio's total return is 432% (blue line) i.e about 432 000 USD generated.
  • With a 1% management fee, the portfolio's total return is reduced already to 383% (orange line), i.e 49 000 USD lost to fees.
  • With a 1% management fee and a 20% performance fee, the portfolio's total return drops to 285% (grey line), ie 146 000 USD lost to fees. Nearly 1.5x the initial investment !

The fund manager's income

Now, let's turn the table and look at the fund manager's point of view. We've plotted below the previous management and performances fees, accumulated over time, that the fund manager would have received over the 10 year period.

We've split them in two :

  • 21 244 USD in management fees (red line).
  • 47 206 USD in performance fees (blue line).

Making a total of 68 450 USD for the fund manager.

This short example shows how management and performance fees (however small they seemingly are) have a major impact over time. Here we clearly identified the direct loss in fees i.e 68 450 USD, and the indirect loss (potential profit you would have made by investing those fees) i.e 146 000 USD - 68 450 USD = 77 550 USD. The indirect loss, in this case, is even greater than the paid fees ! Keep in mind that this example only takes into account management and performance fees. Funds may charge other fees such as transaction fees, operating costs, etc...

The good news

In the last two decades, there's been a downward trend in fees for mutual funds and exchange traded funds. According to a Morningstar's report in April 2018 called "Morningstar's Annual Fund Fee Study Finds Investors Saved More Than $4 Billion in 2017", the asset-weighted average fees of 25,000 U.S. open-end mutual funds and ETFs declined over the last 3 years : 0,63% in 2015, 0.56% in 2016 and 0.52% in 2017. Morningstar estimates that investors saved more than $4 billion in fund fees in 2017 by continuing to gravitate towards low-cost funds .

This trend is also confirmed by the ICI report called "Trends in the Expenses and Fees of Funds, 2017", which shows fees decreasing between 1996 and 2017.

Lower your pitchforks

Yes, you read that correctly. We've been bashing on fees in this article showing how they can severly impact a portfolio over a long period of time. However let's not forget that it's the job of an investment manager or of a financial advisor to constantly find investments adapted to your risk profile, and this must be compensated. The purpose of this article is not to tarnish active investment by any way but to raise greater awareness on fees.

The entire example above was generated with the Financial App (here). Feel free to try it out with other examples, and share your results !

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