Everyone knows that the majority of an iceberg is below the waterline, typically eight-ninths of the volume.  What is less well known is that fees on an investment portfolio often work the same way.  Some fees are ‘above water’ and easily transparent to the investor while other fees are ‘below the waterline’ and hidden from the investor.


The ‘above water’ fees comprise adviser fees and custodial fees.  Adviser fees are charged by your Financial Adviser to cover the day-to-day management and monitoring of your investments, portfolio engineering and modelling, corporate actions, cashflow management, reporting and communication.  This fee often ranges from 0.5% - 1.5% per annum depending on the amount of capital invested.

Custodial fees are charged by your Custodian to cover portfolio administration services, including the recording of transactions, handling cash, allocating income, reporting and preparing tax statements. This fee typically ranges from 0.1% - 0.5% per annum, again depending on the amount of capital invested.

‘Below the waterline’ fees are the fees charged by managed funds, known as their Management Expense Ratio or MER.  The MER is charged to cover their annual operating expenses, for example, staffing, management, administrative, accounting, legal, advertising and all other expenses.

This fee isn’t always disclosed to investors yet can reach up to 4% per annum for retail funds.   The exact MER can vary considerably depending on the:

• Approach of the manager – passive Index Funds should be less expensive than Active Funds as there is considerably less trading;
• Size of the managed fund – larger funds should be less expensive than smaller funds;
• Type of managed fund – hedge funds are usually more expensive than retail managed funds, which in turn are usually more expensive than wholesale managed funds;
• Type of underlying investment – fixed interest should be less expensive to manage than equities.

What’s more, a ‘Balanced’ fund (which invests in a combination of cash, fixed interest, property and equities) can diversify its holdings by investing in a suite of managed funds itself, resulting in an additional layer of MER.  In the industry, this is called a ‘Fund of Funds’ structure and many New Zealand KiwiSaver and superannuation providers invest in this way.

Below is an example of how these fees can affect a portfolio in three situations:

1. Investing with a client-focussed Financial Adviser who recommends wholesale funds.
2. Investing into retail funds with a typical MER.
3. Investing into retail funds with a typical MER that subsequently invest into other retail funds with additional MERs.

There is clearly a material difference between Situation 1 and Situations 2 and 3 – and these extra fees are charged year after year.  In periods of lower performance higher fees can mean the difference between positive and negative investment returns.  

So when you next meet with your Financial Adviser, ask the question: ‘What are the total expenses I am paying on my investment portfolio, including MER?’  If the response is ‘I don’t know’ then you should definitely change your Financial Adviser!  If the response is ‘over 2.5%’ then you need to seriously consider whether the investment return you are earning or their additional service offerings merit the fees you are being charged.

By keeping this question in mind, you can ensure that your investment portfolio does not suffer the same fate as the Titanic, albeit in much slower fashion.
 

Disclaimer

“The opinions expressed in this article are those of Stewart Group’s advisers and should not be considered as advice. Investors should obtain professional advice regarding their own financial circumstances and objectives before making any investment decision.  Under the Financial Services Act 2008 a copy of our Disclosure Statement is available on request and free of charge."