Investment Risk and Fees

Recently, it has been suggested by one financial commentator that the reason why investment advisers recommend aggressive portfolios is because they can charge higher fees.  The assertion by the commentator is spurious, and shows that the commentator has little or no understanding of how reputable investment advisers are remunerated. 

The majority of fee based advisers, charge their clients on a funds under management basis.  Their fees are unlikely to differentiate between cash, fixed interest, shares, hedge funds or any other asset class.  With regard to their fees, it is irrelevant, as to how aggressive or defensive a client’s investment portfolio is.  The fee will be the same for the same value portfolio. 

If an investor is ultra conservative, it is unlikely that they will have a fee based investment adviser.  The vast majority of the investor’s assets will be held in bank deposits, and the term deposit amounts are often large.  The size of their term deposits invariably attracts the attention of bank advisers, and investors often get asked to invest in another bank investment product, invariably a mortgage trust. 

With few investment advisers charging greater than 1%, it can be argued that the most conservative investors, who are invested primarily in bank deposits, are in effect being charged more than aggressive investors.  However these costs are effectively hidden, as a net of fees interest rate is given to the investor.  Bank margins are often greater than 2%, well above the margins that investment advisers charge.

Over the long term it is expected that more aggressive investment portfolios will generate more fee revenue, than conservative portfolios.  This is because the expected investment returns are higher, leading to higher portfolio values.  Of course there is always the possibility of a rocky investment return path, so the average daily portfolio may in fact be lower than that of a conservative portfolio starting off with the same portfolio value.  The key factor in determining how aggressive a client’s portfolio should be is the client’s risk profile.

For share brokers, who are principally financially rewarded by the number of share trades that they generate, it is very likely that they will earn significantly higher revenues from clients with more aggressive portfolios.  These clients are by nature likely to trade frequently.  The more frequently they trade, the greater the returns will be for the share broker.  At a 2-3% brokerage round trip for share trading, it is these aggressive share broking clients who generate the majority of revenues for share brokers.

For conservative clients, what shares they hold, will often be purchased on a passive buy and hold investment approach.  They will also buy fixed interest, again with a buy and hold approach.  For share brokers, these are low value clients.  These investors invariably want good quality relatively conservative investment advice and are prepared to pay a fee for the advice.  They make great clients for fee based investment advisers.  What’s more, they realise that they do not need to invest aggressively to make consistent above average investment returns.  This then brings them peace of mind, which is well worth having in volatile times.