Understanding the cost of investment management

Across the institutional investment community, disclosure and transparency of costs continues to be evolving, but not fast enough. A paper by Commonfund Institute reveals only 18 per cent of respondents in an endowment survey reported incentive and performance fees paid to asset managers despite the fact that nearly 85 per cent of respondents reported having asset allocations to alternative investment strategies. There is still more work that remains to be done.

Commonfund Institute, which is dedicated to the advancement of investment knowledge among non-profit organisations and serves institutions, foundations, health care institutions and other charities, has written a paper for the long-term investor community on the costs of investment management in a bid to empower non-profit invest

The paper aims to help fiduciaries understand why there is this deviation in reported costs, provide an overview of the different types of costs, both undisclosed and disclosed, and give fiduciaries well-informed questions to ask their managers.

The CUBO-Commonfund study of endowments in 2014 showed that the median all-in cost reported by respondents was 50 basis points. Very few of these institutions were able to provide specific breakdowns, although most could name the components of those costs by category. Only 18 per cent included incentive and performance fees paid to asset managers despite the fact that nearly 85 per cent of respondents reported having asset allocations to alternative investment strategies.

A more detailed estimate of total costs comes from Commonfund’s investor services group, which analyses costs for around 80 client organisations, which suggests costs are more like 100 – 175 basis points, and even more for more complex portfolios.

The paper explains that fees are known – and frequently set out in detail in a manager’s or service provider’s invoice – and can, therefore, be analysed and controlled. But Costs are not necessarily invoiced and can be much harder to understand and control. The problem is exacerbated by the fact that different types of long-term investment pools report their investment performance in different ways. Non-profit organisations such as colleges, universities, and independent schools, foundations, operating charities and healthcare organisations generally report their investment results net of costs. The practice among public pension plans, however, is typically to report returns in gross terms.

“Because fees and costs – both disclosed and undisclosed – determine what institutions get to keep and spend in support of their missions, it is important to understand their nature and range,” the paper says.

“Furthermore, as a fiduciary matter, several compelling reasons exist to support a better comprehension of cost issues.”

The paper says, in particular, that it is incumbent on fiduciaries to have some understanding of the fee structures in limited partnerships, highlighting that they contain compensation structures that include incentive fees and other forms of potential income for the general partner, many of which are undisclosed.

To access the paper click below

Understanding the Cost of Investment Management – A Guide for Fiduciaries