Investors need to be aware of the impact fees have on a portfolio’s overall return over different time periods
One year back Larry Bates, a veteran of the world of fixed-income investment banking, unveiled the concept of the T-Rex Score — an investor’s total return efficiency index that combines the gross return and the fees paid to earn that return.
“Your T-Rex Score represents the percentage of your total investment gain you actually get to keep,” said Bates, noting investors need to be aware of the impact fees have on a portfolio’s overall return over different time periods. Bates also launched a website with a book scheduled for this year.
The fees, over time, add up, reflecting the compounding effect of lower annual net returns. For example, a $10,000 investment generating annual returns of 6.4 per cent — with all distributions reinvested, with annual fees of 1.75 per cent and a 25-year time horizon — generates a T-Rex Score of 57 per cent, meaning fees eat up 43 per cent of the return.
This year, a similar message about fees has again been front-and-centre in the advertising campaign of Questrade, an online brokerage company. The firm’s latest advertisement features a client who wants to move her account because of high mutual fund fees and low returns. The adviser says: “It’s your money, but trust me it’s probably not the best move.” The client replies: For whom, “my family or you?”
Bates said investors’ awareness around the long-term impact of fees “is growing.”
“Two per cent fees can wipe out half of your return and investors are becoming more cognizant of this, particularly as more efficient providers emerge,” he said.
For Bates, the Questrade advertisements, along with those of other online investment providers, “are raising awareness of the long-term damage of fees.” Calls to Questrade weren’t returned.
All the focus on fees leads to the role financial advisers play in selecting investments for their retail clients. That discussion is heightened because regulatory bodies have not universally implemented a fiduciary duty for advisers.
Given the discussion around the need for such a standard, and the need or otherwise to get rid of trailer fees, lots of research has been produced showing the negative effects of such a move — although the assumption would be that advisers would recommend products that pay the highest commissions.
But a recent academic paper (updated in December) tosses another variable into the mix. Titled the Misguided Beliefs of Financial Advisers, the paper is authored by three U.S. academics and published as a research paper of the Indiana University’s Kelley School of Business.
What’s interesting is that the paper uses data provided by two large unnamed Canadian financial institutions. (Both are mutual fund dealers who manage $20 billion of client assets, none in individual stocks.) The authors had “comprehensive” trading and portfolio information from more than 4,000 advisors and almost 500,000 clients during the period 1999 to 2013. They were also given the advisers’ personal trading and account information.
Guess what? According to the analysis, advisers “invest their personal portfolios just like they advise their clients.” In other words, they trade frequently, prefer actively managed mutual funds, chase returns and under diversify. Both the client’s and adviser’s return trailed the market by about three per cent.
“Advisers give poor advice because they have misguided beliefs,” the authors conclude, a situation they argue can’t be solved by eliminating conflicts of interest.
Maybe, but Bates gets the final word. Most of the advisers “can only offer expensive product which damages return. The advice should be to buy inexpensive product,” he said, adding he hopes the two institutions with the laggard performance numbers have been offering remedial training to their advisers and better advice to their clients.