This article has been written by expert contributor, Vanguard Australia.
There’s a lot more to choosing an investment fund than the advertised management fee. These other elements can make a big difference to your returns over time.
When hunting around for a good deal on an investment product, some investors may be lured by the management fee.
In the case of exchange traded fund (ETF) products, the advertised management fee is sometimes referred to as the management expense ratio (abbreviated to the MER).
An investment fund’s MER is a ratio that includes total annual management fees and other expenses such as transaction charges, account fees and other operating costs. It’s normally shown as a percentage of every dollar invested.
For example, an ETF product with an annual MER of 0.1 per cent charges $10 annually for every $10,000 invested.
The MER is deducted daily from each fund and is therefore reflected in the unit price of the ETF.
But there are usually other external costs payable not taken into account in the MER that are ultimately deducted from investment returns, such as stock brokerage fees and certain taxes.
So, you really need to look beyond the advertised MER to really understand the investment you’re potentially purchasing.
Things to check beyond the MER include the actual assets of the ETF (how many and which companies it invests in); the scale of the ETF product provider (assets under management); its depth of investment expertise (the size of its portfolio management team); and its long-term investment track record. However, keep in mind that past performance is not an indication of future performance.
Investment assets under management
It’s important to know exactly what you’re paying for when you invest, because there can be big differences between investment products in terms of their total number of company holdings.
For example, consider that an ETF that invests in the top 300 companies on the Australian Securities Exchange (ASX) is investing in 50 per cent more companies than an ETF that only invests in the top 200 companies on the ASX.
That can make a difference both in terms of market coverage and investment diversification because, in the case of the first ETF, your money is being spread across 100 more ASX-listed companies (that is, 300 versus 200).
That’s just one example. So, make sure when you compare MERs on ETF products that you’re really comparing apples with apples on the actual underlying investments.
Scale can deliver benefits
Generally speaking, large global asset managers have considerable financial firepower.
That firepower can translate into significant long-term financial benefits for their investors in the form of relatively low overall management and transaction costs.
In asset management terms, having scale can enable large asset managers to negotiate the best deals with service providers and then pass on these cost savings to their investors, including transactional cost savings.
These can include stock brokerage fees, trading commissions, and custody fees.
Large asset managers are more likely to have the financial clout to invest in state-of-the-art trading systems, operated by market-trading experts, to track or “replicate” index benchmarks, while smaller managers may not have these financial capabilities and may have limited access to resources.
Trading capabilities are skillsets that can generate efficiency gains. These gains can then potentially be passed back to investors in the form of lower trading costs.
Investment expertise
Size can also be important in the context of investment management expertise.
That is, there can be benefits for investors in having access to a large, global asset management team managing your investments. For example, having a depth of portfolio management experience and a global trading capabilities at your disposal can be a major advantage.
Add to that other senior experience from the likes of investment analysts, economists, researchers, product specialists, and financial experts from other areas.
You should also look at portfolio management track record. What sort of long-term historical track records do the portfolio managers and funds have when it comes to performance after all fees have been taken into account? However, as noted above, past performance can be informative but should not be relied upon as, and is not, an indication of future performance.
Good managers can track indexes very tightly and can add incremental value that may cover some or all of your management fees.
Conclusion
Costs always matter when it comes to investing, but there are a range of other considerations to take into account when selecting an investment fund or an asset manager.
The advertised MER is certainly one part of the equation, but make sure you also understand what you’re potentially investing into. In other words, compare apples with apples, not oranges.
Factor in the asset manager’s financial scale and expertise – two aspects that can lead to lower costs and potentially deliver higher investment returns over the long term.
Successfully taking advantage of these opportunities can help to lower other costs beyond the MER and can provide access to financial and human resources that may enhance the end returns of all investors.
Vanguard is the trusted name in investing. Since our founding in 1975, we’ve put investors first delivering on our mission to give them the best chance for investment success. More than 30 million investors worldwide invest with us, benefiting from our low-cost and high-quality managed funds and exchange-traded funds. Learn more about Vanguard here.
The above material has been republished with the permission of Vanguard Investments Australia Ltd.