Reply to @wellhandy : Warning: Not 100% accurate and subject to changes if the situation change.
The fee structure depends on cost, market trend and survivor ship.
First on cost: some institutional investors, they demand alot of reports on the market, updates and company visits by the fund manager. The fund manager must be prepared to do detail explanation of their holdings to a few committees to win business. Risk committee, investment selection committee, compliance committee etc....just imagine the fund manager is a maze runner trying to level up. In this case, no management fee very difficult because the product is a high cost product to begin with. The customer demands alot before even investing and may demand more after investing.
On Market Trend:
In the past, some fund managers are able to generate 20%+ a year so even after management fees. In that case, the fund manager can charge what ever fees he wants. Usually these funds in the equity space employ a concentrated portfolio strategy to pick like 20 stocks, so that their chances of getting outperformance is higher than a diversified approach. They justify their fees by the number of company visits and on the ground research. Sadly, in the last 5 years, such strategies have not worked well so that is why you observe the fees, especially management fees have been dropping towards zero(ETFs). This is because in this market cycle we observe that simple strategies like ETFs are working better than complicated strategies using stock picking. Experience investors know that investment strategies do not work forever. So ETF investing will also come to an end. When the pendulum swings from simple ETFs to favor complicated strategies, the fees will increase again.
On Survivorship:
The market favors funds with management fees very significantly. This is because, some no management fee funds will have a few years of underperformance and earn no revenue. These funds will die. So investors are left with funds with management fees again after one cycle. Investors should understand that ETFs are essentially a no management fee and no performance fee fund. So if the market corrects, and the correction last for many years, these funds are most vulnerable to die.
In short, fee structures are dynamic. There is no best fee structure forever. When the few factors above change, investors will be willing to pay more fees for more returns.
A high percentage of funds are either average or below average, just like a high percentage of stocks are average or below average, underperforming the index.
Reply to @wellhandy : Warning: This is not investment advice. You are solely responsible for gains and losses from your own investment decisions.
Investing strategies come and go. At the moment ETF is all the rage. Buffet is wise to make the comment because he knows that at the current valuation levels, ETF returns are going to be lack luster for next 10 years and the chances will very likely shift to favor stock pickers. Small cap have been lagging large cap in recent years but this will also change. So stock pickers and trend followers may have a come back for next 10 years. This may happen only after the current cycle ends(crash).
About fund managers investing in ETFs, sometimes fees may be justified if the risk management is superior. For example, some fund managers use volatility and valuation to decide on how much percent of their portfolio to put in an ETF of a country. So the allocation percentage is the value add to smooth out returns over a time period. And many investors will pay more fees for lower volatility.
I am not disagreeing with the main thesis that it make no sense to pay managers to allocate to ETFs. I am just highlighting some exceptions to this rule that investors may have to consider. Alpha usually comes from exceptions.
So what is the best fund fee structure? Anyone?
Reply to @wellhandy : Warning: Not 100% accurate and subject to changes if the situation change.
The fee structure depends on cost, market trend and survivor ship.
First on cost: some institutional investors, they demand alot of reports on the market, updates and company visits by the fund manager. The fund manager must be prepared to do detail explanation of their holdings to a few committees to win business. Risk committee, investment selection committee, compliance committee etc....just imagine the fund manager is a maze runner trying to level up. In this case, no management fee very difficult because the product is a high cost product to begin with. The customer demands alot before even investing and may demand more after investing.
On Market Trend:
In the past, some fund managers are able to generate 20%+ a year so even after management fees. In that case, the fund manager can charge what ever fees he wants. Usually these funds in the equity space employ a concentrated portfolio strategy to pick like 20 stocks, so that their chances of getting outperformance is higher than a diversified approach. They justify their fees by the number of company visits and on the ground research. Sadly, in the last 5 years, such strategies have not worked well so that is why you observe the fees, especially management fees have been dropping towards zero(ETFs). This is because in this market cycle we observe that simple strategies like ETFs are working better than complicated strategies using stock picking. Experience investors know that investment strategies do not work forever. So ETF investing will also come to an end. When the pendulum swings from simple ETFs to favor complicated strategies, the fees will increase again.
On Survivorship:
The market favors funds with management fees very significantly. This is because, some no management fee funds will have a few years of underperformance and earn no revenue. These funds will die. So investors are left with funds with management fees again after one cycle. Investors should understand that ETFs are essentially a no management fee and no performance fee fund. So if the market corrects, and the correction last for many years, these funds are most vulnerable to die.
In short, fee structures are dynamic. There is no best fee structure forever. When the few factors above change, investors will be willing to pay more fees for more returns.
More funds should follow the likes of Li Lu and Mohnish and just copy the structure Buffett used during his partnership days.
Much more alignment of investors interest compared to the huge fees most fund charge currently.
Not that it would help all of them to beat the indices magically but still would help save much more of the investors money.
Reply to @marginofsafety : +2
A high percentage of funds are either average or below average, just like a high percentage of stocks are average or below average, underperforming the index.
Reply to @wellhandy : Warning: This is not investment advice. You are solely responsible for gains and losses from your own investment decisions.
Investing strategies come and go. At the moment ETF is all the rage. Buffet is wise to make the comment because he knows that at the current valuation levels, ETF returns are going to be lack luster for next 10 years and the chances will very likely shift to favor stock pickers. Small cap have been lagging large cap in recent years but this will also change. So stock pickers and trend followers may have a come back for next 10 years. This may happen only after the current cycle ends(crash).
About fund managers investing in ETFs, sometimes fees may be justified if the risk management is superior. For example, some fund managers use volatility and valuation to decide on how much percent of their portfolio to put in an ETF of a country. So the allocation percentage is the value add to smooth out returns over a time period. And many investors will pay more fees for lower volatility.
I am not disagreeing with the main thesis that it make no sense to pay managers to allocate to ETFs. I am just highlighting some exceptions to this rule that investors may have to consider. Alpha usually comes from exceptions.