Looking Back to the Future – Why Past Performance Should Not Justify High Fees

Past performance is not an indicator of future returns. We often see variants of this phrase in investment materials but it should not be viewed simply as legal gibberish – it should underpin how we think about investing. Nothing is guaranteed.

It is troubling when many traditional wealth managers emphatically refer to the past to justify their charges. They defend their high fees by talking about their past performance, often omitting to mention the historic growth in markets overall.

In any market, excessive fees are hugely damaging. So it’s always a good time to get realistic about the relationship between performance and fees.

Future performance may not compete with the past

Over the past several decades investment portfolios have typically benefited from strong performance – since the end of 1989 global equities1 have returned in excess of 8% annually. Since the end of 2008 these equity returns have been greater than 11%2, while over the same period, UK government bonds have returned 4.5%3.

A range of factors, including a benign and stable interest rate environment, meaningful corporate investment and significant economic and fiscal policy support have driven these gradual but persistent positive investment returns – with a few inevitable hiccups along the way.

Yet this level of consistent return is not likely to endure with global equity valuations now at relatively elevated levels, bond yields close to all-time lows and serious economic headwinds on the horizon, whether closer to home with Brexit or further afield with slowing US and European growth. In fact, everyone I meet these days is realistic that the next decade or two will be challenging for investors relative to the more recent past.

There is likely to be growth, but just not at the heady levels of before. And with the persistent effects of inflation it is still much better to be invested than to sit on the side-lines. But with returns becoming more difficult to achieve, investors that are paying excessive fees – often justified by almost arbitrary potential future asset returns – are likely to be getting a raw deal.

In an environment of double-digit returns, paying 1.5% to 2.5% in annual fees may have been acceptable – but that simply doesn’t add up if future returns are closer to 5-6%.

A stark choice: more money for your future, or someone else’s?

Would you intentionally give up a third to one half of your total annual return in fees? Not likely. And it’s not necessary, either.

The trouble is, half of all investors don’t even know exactly what they pay in fees each year – as our investor behaviour research conducted with YouGov last year shows – while 72% of those polled cited transparency as the issue that matters the most to them. See the disconnect?

While nobody can accurately predict what stock and bond markets will deliver in terms of future returns, we can control what we pay to participate. If future asset returns are less than they have been historically, fees need to be substantially lower to allow investors a chance to accrue reasonable net growth of their assets.

Having a high-quality yet low cost investment service is one of our founding principles. Even a 1% difference in annual fees has a considerable impact on net long-term returns as this article shows.

You can also assess the impact of fees on your potential returns by using these handy projection tools.

And, if we are all wrong to worry, and returns go back to 8% a year, why not keep an even bigger share for yourself?

Please remember that when investing your capital is at risk.

1 MSCI World Total Return denominated in GBP, for the period 31-Dec-1989 to 31-Dec-2018
2 MSCI World Total Return denominated in GBP, for the period 31-Dec-2008 to 31-Dec-2018
3 FTSE Actuaries UK Conventional Gilts All Stocks Total Return Index for the period 31-Dec-2008 to 31-Dec-2018

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