Money Talks: Performance versus fees
As we watch the slow migration of our friends from the north leaving paradise, many will continue to watch closely as events around the world unfold with a keen eye on their portfolio performance.
Of course, concerns about performance have taken a backseat for many as the stock market continues to recover from the massive 50 percent selloff from 2009. Yes, with each passing day and week, retired investors watch as this market continues unprecedented growth. However, in light of the gravity of this market run with no clear rationale behind the performance, many have embraced the idea of adding alternative investments to their portfolio simply based on the length of this market run. This approach makes sense for many since at some point even the Wall Street spin machine will agree that there will be need for some type of corrective action. Many believe that every new record high simply puts us that much closer to the day of reckoning.
With this in mind, many are lost on the concept as to the nature of performance versus fees as a result of the recent “one direction” winning stock market. In most cases, as with traditional stock, bond and mutual fund portfolios, the fees are one of two types: comprehensive annual management fees or traditional commissions charged by the individual transaction. The latter has been a dying breed for years as there lays an obvious conflict of interest when the advisors are compensated regardless of portfolio performance. The new breed of annual management fees allows both the advisor and investor to have the same objective: success.
Simple math tells the story here. Certainly any financial advisor would rather collect fees on a portfolio with rising values as opposed to the opposite. This translates to more money for all involved. Yes, winning changes everything. However, what is lost on the majority of investors are the small markups in price with both stock and bond transactions. For instance, consider a purchase of 1,000 shares of ABC stock. The trade confirmation will reflect the purchase price in writing. However, the reality is that there could be a small mark up in the price versus the actual selling price when purchased. If a money manager buys a stock position for an average price of say $25.50 per share, there may have been an opportunity to actually make the buy transaction for say $25.20 per share. The difference seems meaningless as it is nearly impossible for investors to track, yet the cost to the investor in this case was an extra $350.00. Consider the performance versus the fee; 1,000 shares x .35 cents = $350 boost to the advisor's bottom line. Now multiply this by numerous transactions during the course of the year.
Of course, winning each and every day as we have for months now makes this seem insignificant. Performance and fees all too often are not equally correlated with traditional stock portfolios. This is an ideal time to address not only the value of adding alternative investments to a portfolio for diversification and potentially better performance, but at the same time we can get a better perspective as to how both the manager and investors can enjoy sitting on the same side of the table.
When we consider the compensation model for manage futures, we see a combination of both annual fees and incentive compensation. The annual fees are necessary to simply cover the costs of conducting business. These will be similar to fees charged by stock advisors. However, the incentive fees are the real game changer. Commodity Trading Advisors will traditionally charge a percentage of the profits each year. Zero profit equals zero compensation.
Conversely, a managed futures portfolio must continue to achieve new highs in value in order for the advisor to collect the incentive fee. The Futures advisors cannot charge the incentive fee while recovering losses from previous highs; the Futures advisor must recover all losses and then surpass the previous high water mark in order to collect the incentive fees. This level playing field of performance versus fees certainly allows for the life of a SWAN: Sleep Well At Night.
William F. Hague is a managing partner of Hague Wealth Management; 239-389-1999 or WFHague@earthlink.net. The opinions and observations stated above are those of the columnist.