Low fees good, high fees bad ... really?

Blind faith in the mantra that low fees are good and high fees are bad just doesn’t stand up to close scrutiny.

 

Private investors have become obsessed with fees — and so have regulators. We now take it for granted that high fees are “bad” and low fees are “good”.

But is it true?

Investment operates under a set of guiding principles and so too should investment fees but a blind faith that low fees are for winners and high fees are for losers does not stand up to close scrutiny.

The comprehensive examination we have seen of fees in the financial services area over the last decade has improved the investor’s chances of success to a significant degree. Very few investors are now unaware of fees and items that we take for granted such as all-important management expenses ratios — MERs — have at the very least put most products on a sensible setting.

The fees obsession has flaws however. Just earlier this week my colleague Monica Rule (a former ATO compliance officer who specialised in SMSF audits) made the valid point in The Australian that anyone running an SMSF should not assume that low audit fees on their annual returns are necessarily better.

Annual SMSF audit fees can be as high as $2,000 or as low as a couple of hundred dollars. Rule pointed out that no less an authority than ATO commissioner Chris Jordan had complained about the poor standards of audits that had cost less than $400 — these may represent perhaps one in five of all audits judging by recent ATO statistics.

Rule warned investors that mistakes made in SMSF audits could be very costly in the long run — she did not even begin to outline the stress and cost of a potential ATO “special audit”.

Curiously, most readers railed against the very notion that a more expensive audit might be better value.

It is certainly time to test the “low fees good, high fees bad” principle. If you buy a mediocre investment product with a standard fee of, say, 2.5 per cent, and it just about manages to match the index: Is that a measure of investment success?

What if, instead, you buy an investment product — offering to invest in the same area on the same terms, such as a fund concentrating on US shares — which charges a performance fee of 20 per cent ... and it shoots the lights out.

You double your money in a year. Yes, you drop 20 per cent on fees so you effectively make 80 per cent on the money ... are you a loser because you coughed up 20 per cent on fees in this instance?

If the product had done nothing it would have cost you nothing in fees. Many would argue that as long as the investor is fully aware of the risk and the deal they are accepting on fees then all is fair.

Of course in an ideal world you would like ordinary fees on extraordinary performance but that is not how the market works.