Practical analysis for investment professionals
21 August 2017

Ignoring Fees Doesn’t Beat the Market

It only decreases trust and credibility.

Why did I lead with this bold title and subheading?

Because a large investment firm recently made bold assertions that I found quite intriguing:

“Contrary to popular belief, some [active] mutual funds do beat the index on a consistent basis,” and its “select” group of funds, in particular, “beat the index . . . 93% of the time.”

It all sounded great, so I gathered, arrayed, and compared information about the firm’s growth-of-a-dollar charts and its highlighted performance claims.

Specifically, I looked at three of the firm’s best-performing “select” funds versus the benchmark it says is appropriate, the S&P 500:

  • Fund A, the firm claimed, outperformed the index 98% of the time.
  • Fund B, it said, outperformed 96% of the time.
  • Fund C outperformed 91% of the time, according to the firm.

The illustration below is what I found, after deducting the fees the firm states could apply.


Fund Performance after Deducting Fees

Fund Performance vs. S&P 500

Performance figures are for the period ending 30 June 2017 and are provided by the fund company minus the maximum sales charge deduction of 5.75%.


Where’s the “consistent” outperformance?

Not one of these funds outperformed the S&P 500 over the past one-, three-, five-, or 10-year periods ending 30 June 2017 net of all potential fees.

And remember, according to the data, I chose three of the top-performing “select” funds.

I don’t bring this up to vilify any one firm and haven’t named the firm in the text. Culpability is not the point.

I’m just highlighting the marketing games our industry can play by pointing out what bold claims can all too often rest on:

Omissions

In making its outperformance claims, the firm left out large potential fees:

The upfront sales charges, which can be as high at 5.75%, that are assessed on any investment less than $1 million.

As a specific example, the promoted hypothetical investor can’t receive the returns the firm boasts about because all fees are not included in the calculations. According to the firm’s website, a $100,000 investor would be charged a 3.5% front-end sales charge. These fees are not taken into account in the growth-of-a-dollar illustrations or the 93% of the time outperformance claims.

These fees are footnoted with links to other web pages, so again, there’s nothing legally wrong.

But are these performance claims potentially misleading?

I will let you decide, but I hope most would agree that as an industry we can do better.

What is my simple message to investment product firms and fund managers?

Please help improve the state of our profession by being more straightforward.

Just admit you’re in the business of selling products (nothing is wrong with this) and openly discuss all potential fees and conflicts in simple, plain language (emphasis on “simple” and “plain”).

As CFA Institute declared in “Future State of the Investment Profession“:

“To achieve [our] potential to serve the interests of society, the investment industry must not only regain the trust of investors and the public, but retool institutions and services to demonstrate significant value in fulfilling society’s needs.”

What is my bold claim as to what will happen if you aren’t more transparent?

Investors [will] force change by significantly reducing the demand for your services.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/CSA-Archive

 

About the Author(s)
Preston McSwain

Preston McSwain is the managing partner and founder of Fiduciary Wealth Partners, an SEC registered investment adviser and multi-family office that is focused on high-net-worth investors. Previously, McSwain was a managing director at Neuberger Berman and Lehman Brothers, where he was instrumental in the growth of the firms’ UHNW trust and wealth management divisions. He began his career at State Street Bank & Trust. McSwain received a BS in Finance with a concentration in Investment Management from the University of Alabama at Birmingham. He currently sits on the board of the Pioneer Institute, Board of Overseers of the Peabody Essex Museum, and is a member of the Economic Club of New York.

9 thoughts on “Ignoring Fees Doesn’t Beat the Market”

  1. Peter Burton says:

    Hi,

    Excellent article.

    I am curious if the analysis was done using the total return S+P 500 or did you reduce it by the amount an investor would have to pay in a low-fee mutual fund, ETF or equivalent?

    Cheers,
    Peter

  2. Matthew Schwerin says:

    Excellent homework and its a shame that a group would be deliberately misleading with their performance. I believe they feel the pressure that they as active managers face – the world is seeing that index funds and low cost ETF’s are the way to go. We as investment professionals can still add value with our relationship to the client, our picking of the low cost funds, our advice and direction as we help them reach their goals. But to do that with higher costing funds that consistently underperform the market is not doing our best for the client.

  3. Richard Scheele says:

    Preston,

    Thank you for bringing attention to the often unspoken costs that pervade mutual fund marketing. That said, I don’t think the example you chose is the the best illustration.

    For investors who invest in the funds through an advisor in a fee-based account, they will have access to the load waived A shares, which is essentially what was used to calculate those outperformance numbers.

    For investors who choose to invest on their own, the fund family has F1 shares (substantially similar to the A shares) that are now available without a load at Fidelity and Schwab.

    Again, I agree with your broader point and believe it is an important one, I just don’t want people to limit their search for good investments because of a load they don’t actually have to pay.

  4. Lydia O says:

    For large caps, low conviction, benchmark like funds, your assertion above would be near right; for small caps, alts, private markets, perhaps not so much.
    Also looks like on a risk adjusted basis (very critical) and over a full 10yr cycle, fund A performed better than market on NAV – yes? and Fund C, the same as market. only Fund B is slightly shy.

    please note I have no relationship with the aforementioned funds

    1. Chuck t says:

      I think we need to stop using “risk-adjusted basis”. SD is not a good measure of risk. We cant measure or define the total risk of an investment and SD just doesnt cut it.

  5. Jim Watkins says:

    Excellent article Preston. A a securities attorney, I did s similar analysis when I saw such claims. Findings same as yours. Also troubling wax the fact that they represented that study began when their load was much higher than current 5.75%. Tje also used nominal returns instead of liad-adjusted returns, inflating performsnce. The noted in small footnote that returns would have been lower using load-adjusted returns.

  6. Tony V says:

    It would be helpful to investors if there were agreed upon uniform and scientifically based standards to help evaluate performance, not just the total dollar performance but the evaluation of individual calls by traders. One such standard might be the use of Receiver Operator Characteristic (ROC) curves which are often used to objectively evaluate medical performance, drug performance and artificial intelligence classifiers. I think looking across other fields helps bring new ideas to already established ones.

    1. Will Ortel says:

      Tony –

      I agree with you! You might be interested to look into the Global Investment Performance Standards (GIPS) that are created and administered by CFA Institute. “Uniform” and “agreed upon” amount to quite a challenge when taken together, especially globally, but my colleagues on that team do admirable work. You may be particularly interested to review their comments about the future of the standard.

      Thanks for reading, and please keep sharing your thoughts!

      Will

  7. Emma Cheung says:

    Couldn’t agree more! There’s a real need to be transparent and understand what exactly you’re paying for. The team explored this a while back in a blog too and it shows that this applies just as much for products where you think you’re paying relatively low fees too: https://macromatters.lgim.com/categories/portfolio-thinking/how-much-do-you-pay-for-your-free-lunch/

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