Higher fees don’t necessarily mean better performance

I wrote in one of my editor’s letters a few weeks ago about an elderly ex-partner of one of the UK’s big investment firms telling me that when he started out, the management fees on the firm’s funds were under 0.1%. I was amazed by this. A lot of you were amazed too.

We all noted that back then there would have been other fees involved. Transaction costs would have been very high, and there would have been hefty entrance and exit fees too.

Nonetheless, several of you said it just wasn’t possible, so I had a look around for sources showing fees that low.

I have every back issue of the now defunct Statist magazine, and, going through this, I find several articles written by people furious at management fees being over 0.5% a year. That suggests a lower baseline that we have become used to at least.

But then I got an email from a reader pointing out that only as far back as 2001 the total expense ratio (TER) on the Alliance Trust, a group that doesn’t do change fast, was a mere 0.13%. Amazing. But true. Today it is 0.76%.

Our reader asked the following questions on the price rise, and got the following answers.

1 – How do you explain this?

Two issues combine to explain this increase. Firstly, the 2001 figure was not sustainable. Controlling costs was determining investment priorities, and expenditure was being deferred, which was affecting the ability of the investment team to do its job.

This is evidenced by the performance of the trust up to 2001, when it was ranked in the bottom quartile relative to its peers over five years. The other issue is that since 2000 the cost of regulation has increased significantly, and this has fallen hard on the trust.

2 – Do you have targets to get back to being a low-cost investment?

We are acutely aware of the impact of costs on the returns, and we have taken significant costs out of the business over the last four years. It should be noted that Alliance Trust is still has one of the lowest ‘ongoing charges ratio’ (the successor to the TER) of any trust. The global growth sector is one of the most cost effective in the industry and Alliance Trust is one of the most cost-effective within that sector.

That’s all sort of fair enough – although the claim to be one of the cheapest is pushing it slightly when Alliance is 50% more expensive than the trusts with the lowest fees (around 0.5%).

Alliance probably isn’t a bad investment. It is diversified, trades on a discount and offers a perfectly adequate portfolio to the risk-averse long term investor. But so far it also offers proof that increasing charges doesn’t actually improve performance.

Look at the NAV numbers on the chart here and you will see that over the last five years the global growth sector has on average returned 104%. Alliance Trust has managed only 89%.