What Price Is Right?Don Shaughnessy
“The question of whether investors would buy mutual funds if they knew the true cost — and at what point the cost is too much — is moving to the forefront of a raging debate.” is the lead to a story by Barbara Schecter in Financial Post 25 April 2013.
There is a followup on the 27th. Where’s the Transparency? authored by actuary Fred Vettese. The implication is that fees are too high and deferred sales charges and the misalignment of purposes harm the client.
By way of disclosure, I am financially indifferent to this issue, at least as an adviser. I have almost no funds under management and have not sold a new one in the last 6 years.
Are fees too high? Are clients badly served under the current system? Interesting questions but neither article provides the answer. A good answer is deeper. Fees are too high if the value received in exchange for the fees is too little. Until you know both parts there is nothing to talk about.
Management Expense Ratio (MER) is not “cost.” MER is price. Cost includes price as one its components, but it includes other things like risk, convenience, time, information and more. Price as a proxy for cost misleads.
Choosing the lowest MER price is not smart if by paying less you get less, and worse don’t know what was given up. It is the factory-second parachute problem. Would you buy such a parachute for half price without asking why it is cheaper?
Cost is what you give up and value is what you get back. To be fair they must balance.
You cannot have a reasonable discussion, transparent or not, without considering what you get in return for what you give up. There is a material cost to do it yourself and to paying an unknown hourly rate to use skilled people to help balance your portfolio as suggested by Mr. Vetesse.
Ms. Schecter quotes Ermanno Pascutto, executive director of the Canadian Foundation for the Advancement of Investors Rights (FAIR). “Investors do not comprehend the impact of fees on their investments.” True! Absolutely and irrefutably true. To be fair, they do not comprehend the impact of having no fees and no advice, either.
While there is plenty of talk about “the fees are too high”, there is none about what they should be. In the Post stories there are references to what the fees are in other countries. Comparison to American costs is misleading. American costs are not 1% lower. Americans calculate their cost ratio differently. See how here.
Costs of any kind affect an investor adversely. Greatest value for a given cost, and given value for the lowest cost are the desired analysis conditions. Neither article addresses that. Implicitly, they assume there is a way to get something for nothing and you can if you ignore these:
- Successful investing is not a skill-free zone. Investment selection, whether it is to buy, to keep or to sell, is an expensively acquired ability. Could you organize a tax-efficient fund? Likely not.
- Even if people could handle the technicality, it is not easy. There is much more to it, like managing emotions. Urgency hurts you. Fear and greed are bad for yield.
- Do-it-yourself is not a time saver. Include research and skill building efforts in the time. Spending 4 hours a week on your investments will do an incomplete job, and save some fees. Will the saving be worth as much as spending the same 200 hours per year doing what you are good at doing? Not likely.
- Successful investing is technical and burdened with paperwork. You will love keeping track of the cost base for taxes, reporting interest, dividends, foreign income and all of that, tracking trades, checking the prices and quantities. Mr. Vettese did not mention that his pension clients already incur those costs and you probably do not. Not quite the same thing.
- Estimate risk. Risk is defended by information. You have less than you need. News versus fundamentals is like weather versus climate. It means little.
- Do you really think that spending a few hours a week will let you compete successfully with a Harvard MBA with 10 years experience, working 70 hours a week and having access to information you do not even know exists?
- Who is your devil’s advocate and are they cost free? Charlie Munger sometime says to Warren Buffet, “Have you lost your mind?” Who is your Charlie Munger?
- Who checks? You are not objective enough.
Deferred sales charges (DSC) are certainly abused, but on the other hand, for investors with little money, it is the only way to get attention. It is uneconomic for an adviser to deal with an account under $100,000. (Two of the big bank-owned investment companies in Canada have stopped recently.) Front end costs are material. If you want a plan before deciding on a portfolio, you need to decide how to pay for it. DSC’s let an adviser get involved in a businesslike way.
Beyond $250,000 it is usually fair to say that there is no place for a DSC.
The world works like this. Good, Complete, Cheap. PICK ANY TWO. Ongoing, excellent advice and service is not cheap. If you want service and skill, the price must be acceptable to both you and the adviser.
Will regulation help? Regulators normally add cost but little value. Instead, investors should select advisers for competence and service. Few can judge. Designations don’t help much. Investors need to learn fundamental things and many investors can not. With regulation, they may think that they need not care.
Just as wise investors avoid incompetent advisers, wise advisers should avoid incompetent clients or even competent ones with unreasonable expectations. They are trouble.
There is a cost to do something and there is a cost to do nothing. If you think doing nothing costs nothing you are delusional. Regulation won’t fix that reality. Personally I would rather pay a little too much for something that works, than pay too little for something that might not. Take a look at an older article. Cheap is Too Expensive.
At the root is a failure to communicate. There are two possible approaches to clear it up:
- Industry, demonstrate your value proposition. As it is, critics who do not understand, or intentionally ignore that, can argue price without a comparison to value.
- Investors, if fund managers and their advisers charge too much, buy shares in mutual fund companies instead of their funds.
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. email@example.com