Impact of Fees on Investing

Fees Matter.

Minimising cost is a critical part of every investor's toolkit. This is because in investing, there is no reason to assume that you get more if you pay more. Instead, every dollar paid for management fees, sales charges, and trading commissions are simply a dollar less earning potential return. The more fees paid for someone to manage your funds, the smaller the amount left for you.

In a good market investors have a tendency to ignore them and in challenging markets they are scrutinised, but in the end no matter what type of market we are in fees do matter.  The fees paid on the mutual funds directly impact how much the portfolio is worth at the end of the day. 

The following chart was taken directly from the Ontario Security Commissions website, and shows the impact of fees on investment performance. 

Albert Einstein understood this very well when he said, “Compounding is the eighth wonder of the world.  He who understands it earns it and he who doesn’t pays it”. 

Royal Bank made almost $9 billion dollar last year and collectively Canadian banks earned $35 billion dollars, clearly they understand this concept very well. 

If you have any questions about the fees you are currently being charged please contact us. Scout Investments offer comprehensive investment, insurance, and mortgage solutions at the lowest cost to our clients. 

kevin@scoutinvestment.ca

                         

www.scoutinvestments.ca  

                                           

1-800-795-6701

Fundamental Indexing

Enhanced Indexing

Enhanced indexing attempts to generate modest excess returns compared to index funds and other passive management techniques by combining elements of passive management and active management.  Enhanced indexing strategies generally have low turnover and lower fees than actively managed portfolios.

However, enhanced indexing also to a certain extent resembles active management because it allows managers the latitude to certain deviations from underlying index. These deviations can be used to improve portfolio performance, minimise transaction costs and turnover, or to maximise tax efficiency.

Fundamentally based indexes are indices in which stocks are weighted by one of many economic fundamental factors.  A key belief behind the fundamental index methodology is that underlying corporate accounting/valuation figures are more accurate estimators of a company's intrinsic value than the listed market value of the company.  In this sense fundamental indexing is linked to fundamental analysis.

The fundamental factors commonly used by fundamental index managers are sales, earnings, book value, cash flow and dividends. Fundamental indices take advantage of value stock discounts which have been present in international stock markets during the last 30–40 years so it is not strange that they have been repeatedly shown to beat the market. 

There is academic evidence, with statistical significance, that fundamental indices create more value than capitalisation weighted indices and since they are fundamentally based, fundamental indexes can reduce investors chances in participating in bubbles and crashes and reduces volatility while delivering a higher return.

Forty years of back-tested Indices weighted by any of several fundamental factors including sales and earnings, in U.S. markets outperformed the S&P 500 by approximately 2% per annum with volatility similar to the S&P 500.  In non-U.S. markets, fundamentally based indices outperformed capitalisation weighted indices by approximately 2.5% with slightly less volatility and outperformed in all 23 MSCI EAFE countries.

Does your investment manager use a strategy based on sound academic theory and empirical evidence of outperformance?  Or instead are they throwing darts?

Does your portfolio manager outperform the market, after taxes and fees?

Scout Investments offer comprehensive investment, insurance, and mortgage solutions at the lowest cost to our clients. 

kevin@scoutinvestment.ca        

                  

www.scoutinvestments.ca                                      

1-800-795-6701

Disadvantages of Active management

Active management issues –

Active management is simply an attempt to "beat the market" as measured by a particular benchmark or index. For example, an investor might buy or sell certain stocks to try to get better returns than one of the stock market indexes such as the S&P 500 Index or the S&P/TSX Index. 

The aim of active fund management is to outperform the benchmark index for a particular fund, after fees are paid.  Prevailing market trends, the economy, political and other current events, and company-specific factors can all affect an active manager's decisions. So the most obvious disadvantage of active management is that the fund manager may make bad investment choices or follow an unsound theory in managing the portfolio.

 

In reality, a large percentage of actively managed mutual funds rarely outperform their index counterparts over an extended period of time, (although some managers do outperform passively managed portfolios over long periods of time).  

The reason most active mutual funds underperform market indexes are because they are "closet indexers" — funds whose portfolios look like indexes and whose performance is very closely correlated to an index.  These mutual funds are only marketing themselves as “active managers” to justify higher management fees and management of these funds believe that if they only trail market returns by a few percentage points, the clients won’t leave, however if they underperformed the market significantly clients would leave. 

    

Active fund management strategies that involve frequent trading generate higher transaction costs which diminish the fund's return.  In addition, the short-term capital gains resulting from frequent trades often have an unfavorables income tax impact when such funds are held in a taxable account. 

As an individual investor, keep in mind that both active and passive managers are selecting investments from the same pool of equities. Active management should have a place in most investor portfolios but it is important to keep in determine:

Does the manager have a track record of outperforming market benchmarks over extended periods of time?

Is the manager a closet indexer, calling themselves active managers to justify higher investment management fees?

Is my active manager involved in frequent trading, which generates higher transaction cost and additional capital gains taxes?

Scout Investments offer comprehensive investment, insurance, and mortgage solutions at the lowest cost to our clients. 

kevin@scoutinvestment.ca                www.scoutinvestments.ca                              1-800-795-6701