Prepare now for lower investment returns in the future


Stewart Aldcroft


Mutual funds, Fees

If your prospective clients were to be told “I’m sure we can get over 5% per annum returns for you”, what would you expect them to do?

If your prospective clients were to be told “I’m sure we can get over 5% per annum returns for you”, what would you expect them to do?

Probably tell you there are plenty more investment advisers out there that can get better returns for their money. Yes, there are many who will tell clients they can get better returns, but there are few that actually achieve it consistently.

The truth is, in the next few years, as indeed has been the case for the last few years, investment returns are not going to be very impressive. Worse, they won’t be double-digit, and they may even be as low as 5% per annum.

This, of course, sounds quite bad, especially for those of us who can remember when investment returns were consistently over 15% to 20%. But in an era of low, zero or even negative interest rates, and of massive volatility in equity returns, as well as at a time when government bond yields may eventually increase, achieving an average return of over 5% per annum is actually quite good.

There are many clues out there for the observant:

  • Bank deposit rates have remained stubbornly low, and show little prospect of rising much in the near future
  • Bond, especially government bond yields, are also at exceptionally low levels
  • Stock market volatility has increased sharply, with inter-day movements of 2% to 4% occurring quite regularly
  • Alternative investments, such as wine, cars, jewelry and art, are hitting new peak prices at auctions

One of the most interesting clues, however, was the recent announcement by a global top-three fund manager that it was looking to reduce again the total expense ratios (TERs) of its funds, as it had noticed how these fees were increasingly eating into the investment returns achieved by its clients.

This is a somewhat startling observation, but a very accurate assessment of the impact of costs on investing via mutual funds. If TERs of funds exceed, say 2% to 2.5% (the typical average in Asia), this represents almost 50% of the average investment return. Clearly this is too much for the client to bear.

Of course, reducing the TER of funds is not as simple of it seems. There are many factors that make up the total of expenses charged to a fund. These can include:

  • Investment management advice fees
  • Dealing / trading costs
  • Custody and administration
  • Commission rebates to investment advisers
  • Tax, stamp duty, legal and regulatory fees

In trying to reduce TERs, it can be expected that fund managers will try to pare down the largest fees first, meaning their own fees and the commission rebates paid. But this is where there can also be a lot of resistance. After all, if you pay less to those that provide you business, they tend to go elsewhere, where they can earn more. Not an attractive prospect.

Asian investment advisers, banks and other distributors of mutual funds are going to need to start to think about the impact on their revenues in the event of lower commissions.

Should they, as is occurring in the US, Europe and Australia, charge asset-based fees rather than rely on commission? Certainly, the regulators would prefer this. But it can take a while to develop sufficient revenues, and it necessitates a degree of financing to get over the hump.

Please note: views and opinions expressed in this article reflect the views and opinions of the author only and are not necessarily shared by Citi. The views and opinions expressed are not intended as, and should not be taken as, advice or inducement to buy, sell or otherwise trade any securities.

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