Driving down costs

We always say you should control the controllables.

In the investment world, there is a lot you can’t control. Even with thorough research and analysis, we can’t say if the stock market will go up or down over the next few months simply because there are many unknowns which might influence it.

But there is one thing which can make a big difference to returns, that we can largely control and predict in advance – the costs we pay for investing.

Let’s assume there are two funds, one which charges 1% p.a. management fee, with 0.1% for other expenses, bringing the total ongoing charges figure (OCF) to 1.1% p.a.

Or, we could invest in another fund charging 0.1% a year.

If the underlying portfolios perform equally well, the cheaper fund will outperform the more expensive one by 1% a year. Compound that over time, and it makes a big difference to the value of a portfolio.

Within the IFSL Equilibrium funds, we manage about £1.2bn of assets. If we can make the underlying costs even 0.1% p.a. cheaper, that saves our clients £1.2m over the course of a year.

We use a mixture of active and passive (index tracking) funds. Typically (but not always), the index tracking fund is cheaper, so we will only use an active fund where we’re confident it will outperform over the long term (after costs).

When investing in active funds, we always ensure we obtain access to the cheapest share class. Many funds offer a different price for retail investors than they do for institutions.

If we do invest, we will likely be buyers of tens of millions of pounds worth. This provides us significant leverage with the fund manager, and we often obtain additional discounts even beyond the institutional pricing.

Value for money

While cost is important, value for money matters even more. Sometimes, it’s worth paying more for the right fund.

For example, we hold a fund that buys smaller UK companies, and as major investors we asked for a discount.

Their response was that they don’t give discounts to anyone. They only want to manage £500m in their fund, as they believe they will no longer be able to add value in this specialist asset class if it grows larger.

Managing small companies requires more in-depth research than large ones, where all the information is readily available. In this instance, we felt the manager demonstrated great integrity and therefore decided to invest in the fund at full cost. Since then, it has outperformed its peers and demonstrated to us that it’s worth investing in the right fund rather than invest in a cheaper fund with poorer performance because the portfolio is too large!

In other instances, we have taken a different approach.

One example is our India equity holding, where we’ve used an actively managed fund for many years. We have considered passive funds, but historically, they haven’t been much cheaper than active funds. Until recently, a typical India tracker fund cost over 0.4% p.a., while we pay just 0.03% for a US one!

Whilst we were already receiving a discount on the active fund, we asked them if there was more than they can do. They agreed to a slight increase, but we felt it wasn’t enough, as active and passive funds have produced comparable returns in this region. So, we switched to an Indian tracker fund, which now costs less than 0.2%.

Defined returns

There are other ways to reduce costs too.

We invest in defined returns products, which are structured products created by investment banks and provide a pre-determined return in certain conditions (see related article Cloudy with a chance of good returns). For example, we recently invested in a product which will return 11.65% p.a. if the FTSE 100 and S&P 500 are above their start value at any of the first five anniversaries of the product being set up.

As these aren’t managed funds, there’s also no fund management fee – bonus!

Thinking smart

Furthermore, we have significantly reduced costs by using a mix of active and passive funds, applying defined returns sensibly, and negotiating hard on your behalf.

We recently aimed to reduce the underlying fund costs of our Global Equity fund to below 0.4%*. Despite the challenge of reducing costs in an equity portfolio, we succeeded.

For our other Equilibrium funds, three of them already have lower underlying costs than Global Equity and we’ll continue to reduce costs further.

*The weighted average OCF of the funds we hold, excluding Equilibrium’s fees and the costs of running the funds.

This article is an information piece and should not be construed as investment advice.