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Five Myths about fees: The truth behind analyzing fees in the context of investment goals

Jul 4th, 2006 | Filed under: Investment Management Fees

By: Ronald Kahn, Matthew Scanlan, Laurence Siegel, Barclay’s Global Investors
Published: May 2006

Excerpts:

“[Investment] research seldom focuses on fees. As a result, several popular myths exist regarding fees.

“The first myth is that fees should be as low as possible. This baseline myth makes some sense, yet investors who follow this rule will only hold index funds, with no chance of outperformance. Instead, investors should maximize expected risk-adjusted alpha (i.e., utility) after fees. Investors should be willing to pay higher fees to managers with the ability to consistently deliver strong alpha. The lesson here: Don’t analyze fees in isolation but rather in the overall context of return, risk, and cost. Carefully analyze the proportions of alpha and beta the product delivers, and pay appropriately for the combination.

“Investment management fees are a timely topic because of three trends in the investment landscape:

Investors increasingly look to separate alpha from beta.

The cost of beta has dropped to very low levels.

An explosion of new alpha providers, including hedge funds, private equity firms, and even otherwise traditional managers, use unconventional fee structures.”