Asset Risk Consultants (ARC) has issued a note in the wake of the FCA asset management review which aims to help investors determine if they are getting value for money from their investments.
The consultancy suggested that administration expenses as “a rule of thumb” should be in the range of £2,000 to £10,000 per client and be charged on a flat fee rather than as a percentage of funds.
These expenses should also cover issues such as suitability assessments, know-your-client procedures, provision of statements and valuations, tax computations, liquidity management and receipts and payments, ARC said.
For market access, the note suggests: “With index tracking funds available for almost every conceivable asset class, it is possible to estimate the cost of market access for almost any investment strategy.”
The cost is generally calculated on a percentage basis and ARC argues that a fair cost for market access is easiest to calculate if custody costs are disclosed separately.
In terms of applied research, ARC believes for passive strategies this research cost should basically be zero and included in the cost of market access and administration.
The note said there are three main ways DFMs attempt to outperform a benchmark, whether a composite of market indices or a target absolute return. These are through tactical asset allocation, judicious underlying fund selection and superior stock selection.
“To generate positive alpha, or in plain language to outperform a passive portfolio by design rather than by luck, requires skill and skill relies upon applied research,” it adds.
This begs the question, how much should an investor pay for accessing applied research?
ARC said that the principle it applies is that there should be an equitable division of the potential benefits from applied research between those providing the intellectual capital and those providing the investment capital, i.e. the DFM and the investor.
This outcome can theoretically be achieved through an agreed performance fee in the form of X% of the outperformance of a given (investable) benchmark best thought of as the “Value Capture Ratio”.
The investor might retain 60% with the performance fee 40% of the outperformance of the benchmark, but ARC noted such arrangements are rare as DFMs worry about income uncertainty and investors worry the fee may be too generous.
