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The ideas and conclusions within these blogs are the authors' own and do not necessarily reflect the views of Octopus. They are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any investment. For our full terms and conditions, please click here.

Cost-effective investing: the art of getting what you pay for

Oliver Wallin - 19 May 2011

With the UK consumer feeling a little lighter in the pocket this year, many people are re-discovering the lost art of thrift and the importance of getting value for money. Investors have also been striving for greater cost-effectiveness, as evidenced by the surge in popularity of passive investments, index-trackers and exchange traded funds (ETFs).
 
Indeed, it has been suggested that the recent commodities boom was due partly to the sudden surge of ‘hot money’ from investors into this area. Of course, once the hot money floods into a particular asset class, what usually happens is the smart money flows out, as demonstrated by the recent sharp correction in commodity prices. Who would have lost out when the commodities market took a tumble? Not the shrewd financial institutions, such as Goldman Sachs, who announced their decision to pull out of the commodities market two weeks previously. No, it was more likely those retail investors that had chosen to invest in commodity ETFs, and helped to push asset prices even higher, who were left nursing the losses. And there’s the rub.

Investors may think that they are saving money by cutting active managers out of the relationship altogether. But passive investments such as ETFs will only ever get you the replication of the returns of an index (minus fees of course; these investments are not free of charge either) whether that index rises, falls or stays flat.

An active fund manager should be able to spot warning signs up ahead, look out for bumps in the road and know when to adjust their portfolios accordingly. A passive investment, on the other hand, will simply continue down that road regardless, unaware of the need to slow down, change direction or avoid potential obstacles.

As multi managers, we recognise the advantages and disadvantages of active and passive investments, and we carry a blend of both within our portfolios. We choose ETFs in order to give ourselves exposure to markets all over the world, and from diverse asset classes such as property and crude oil, when appropriate. We only invest through those active fund managers we believe they will outperform – after costs – the available passive investments. There will be phases from time to time, when the investment landscape will offer greater rewards for actively managed funds, or for certain active management styles within each asset class. This proved to be the case earlier in the year, when we sold our commodities ETF and purchased a specialist commodity fund, with the flexibility to take short positions, instead.

One of the long held counterarguments against multi manager funds has been that the ‘double layer’ of fund management charges will always ultimately outweigh the benefits. We would suggest that this is only true within those poorly-managed funds where costs and charges are not being considered enough. Such funds are relatively easy to spot and avoid, simply by comparing their ratios of return over risk over two or three year investment periods, and providing the funds you compare are managed taking into account similar levels of risk.

In our experience, a well-managed multi manager fund doesn’t have to add much more than 0.5% to the charges of a single manager investment. We believe that this additional outlay is well worth it, considering the additional benefits a multi manager fund should be able to deliver. Look at it this way. For an investment portfolio worth £100,000, an additional fee of 0.5% works out at an added cost of £500 for year. For that the investor gets a greater depth of investment knowledge and expertise, and far greater diversification. Plus the multi manager will take on the management of all those investments, and all the associated benefits therein, such as active asset allocation, portfolio construction, fund research and selection, ongoing portfolio monitoring, risk management and dealing activity.

We find that when you explain the additional cost of a multi manager fund to investors in those terms, then they usually agree that the 0.5% paid is well worth it in the long run. It helps, of course, that we are able to point them to our performance track record. This, when quoted after fees, is evidence of the value that a multi manager fund can bring, both in terms of investment returns and the investment journey for clients.

Of course, some multi manager funds are better than others, and some will not be able to offer value for money. But where costs and charges are being properly considered, a well-run multi manager fund should be able to clearly demonstrate its value and justify its fees.

Cost should always be a key factor in fund selection, but putting cost considerations before long term investment potential is a false economy, and is likely to do more harm to an investment portfolio than good. When considering costs investors should also try to recognise the long-term benefits that their investment is capable of delivering, not just during periods when asset values are rising, but also when the downside risks are potentially far greater.

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