Two sides of the coin
Investors should consider whether expensive strategies are simply about price or if they actually offer something more personal that’s difficult to quantify, but will ensure their investments are being wisely spent, Kajanga Kulatunga writes.
There’s no doubt cost is an important consideration when choosing investments but it shouldn’t be the only consideration. Providing increased transparency on fees is the latest in a spate of legislative changes impacting how Australians save for retirement.
Regulations coming into play this year are noble in their intent but they have the potential to influence investors into making investment decisions based on cost alone.
Investment returns need to help investors reach their financial objectives, and while investors should have greater transparency of their investments, the cheapest options aren’t necessarily going to be their best option.
New fee and cost disclosures are designed to show the underlying fees that are charged by fund managers. This includes fees for alternative asset classes and derivatives.
Regulators want fee disclosure to be consistent across the entire industry so investors can do an ‘apples to apples’ comparison of fees.
The expectation is that better informed investors are able to choose better investment solutions. While this certainly makes a lot of sense, as with other legislative changes, investors need to ensure they don’t allow an abundance of information to lead them inadvertently into poor investment decisions.
Our brains are wired to use simple short-cuts to make most decisions in life. Given a choice between a lot of information and simple summaries, most people prefer simplicity when making an active choice.
In this ‘automatic decision mode’, most investors are likely to choose ‘fees’ as a simple mental heuristic to make decisions around which investment choice is best for them – and the lower, the better, right? While ensuring you’re getting value for money is an important consideration in any investment strategy, the most important decision is how best to spend your limited fee budget.
Just as not all expensive investments are appropriate, the cheapest are not always the best option either.
Firstly investors should understand that the new disclosure requirements simply provide a clear breakdown of the fees and costs they have been paying all along.
These fees are potentially neither new, nor an increase to what has been charged previously.
Secondly, while having access to some more sophisticated asset classes (like private equity) can mean paying more fees, these investments can also come in handy delivering returns (net of fees) when more traditional assets (like shares and bonds) have struggled in difficult market environments.
Investors should note that these new disclosures may cause confusion, indecision, or regret for them. These are natural reactions to new information. However, the confluence of these emotions may lead many investors into using ‘price’ alone to judge ‘value’. We see similar behaviour from investors focusing on recent returns to make investment decisions – Dalbar’s quantitative analysis of investor behaviour research shows consistent wealth destruction from these behaviours.
As investment managers, we know that return and risk expectations are also important considerations in delivering investment objectives. There is no value investing in assets that have low fees if they can’t deliver the return or risk characteristics required to achieve those objectives. Fees are always a consideration when choosing investments, because strategies are designed to deliver benefits to investors, net of fees.
A better approach for investors when evaluating fees and costs may be to construct a checklist of what different funds offer, and consider whether expensive strategies are simply about price or if they actually offer something more personal that’s hard to quantify, but helps you sleep at night.
As a result of the new fee and cost disclosure, investors will be in a better position to understand the fees they pay and they’ll be able to more easily compare them across funds. Another purposeful outcome of this new fee disclosure would be for investors to question whether the fee budget for their investments is being wisely spent.
Kajanga Kulatunga is a portfolio specialist at NAB Asset Management.
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