(How to) Audit Your Own Investment Program

Posted by: Thomas F. McKeon, CFA on April 29, 2019

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You might be surprised at what you find.

Any investment program will have some result. Whether it will be adequate for your own situation will take years to know definitively. But some things you can do now will improve your odds. Until you understand the moving parts, the total expense burden of your program and the long term impact of compounding returns, you will not know what your true cost is—both now and in the future.


The return pie in any given period is finite. You share your gross returns with the vendors in your investment program. The inescapable truth is that investors earn returns net of all costs. Legendary Vanguard Mutual Fund family founder Jack Bogle, derisively referred to the food chain of vendors who thrive in the financial services business as “croupiers.” What you should hope to find out with your audit is if your financial advisor/vendors is/are getting rich at the expense of your outcome, or if you are paying a fair expense burden for your circumstances, and outcomes.


We recently wrote about a large county pension that came to its senses and fired a very large hedge fund for poor performance. Over the previous five years, the hedge fund had earned more in fees than the county pension had earned in returns from the hedge fund’s services.


Individual and institutional investors should have a clear understanding of how their investment program is organized and how much it costs.



Costs are the one thing that have the most direct and immediate impact on investment outcomes and over which you have most control. They come in several forms:



Do you pay someone directly for investment advice? It could be an asset-based fee, a flat fee or retainer, or an hourly rate.



Portfolio managers charge an asset-based management fee. This is true whether the portfolio comes packaged in a separate account, mutual fund, ETF, annuity, or private partnership (hedge fund). These fees can vary widely depending upon the vendor and package. Various back office investment product and technology platforms that advisors sometimes outsource to charge fees as well.



Some investment products (mutual funds, annuities) pay a salesperson a commission.


Commissions & Market Impact

When securities are bought or sold, a transaction commission is charged. For some securities—typically bonds—there is no explicit transaction commission, but the broker is compensated by marking up or down the price of the bond, keeping the skim and giving the net to the investor.


When portfolio managers of a mutual fund trade they pay an explicit transaction (see commissions above) and they also bear market impact costs—which are the costs of impacting market prices with large orders. Active managers pay more in commissions and market impact.


Internal Charges

Mutual funds and other commingled vehicles charge internal fees that are not always obvious to the investor. They are real nonetheless and can degrade net returns significantly. Some funds charge additional fees to pay for distribution.


Calculate the cost burden in terms of absolute dollars and as a percentage of your portfolio and net return.





Markets & Exposures

A recent examination of a handful of local foundation financial statements revealed that the typical portfolio held only three asset classes: domestic stocks, domestic bonds and cash. Investment were made through mutual funds. Was not clear whether the funds were low-cost, index-based, no-load funds or expensive, broker-sold funds.


Any market exposure that could potentially enhance returns, limit risk or both could (should) be included in a properly allocated portfolio, provided it can be accessed cost-effectively.


With global markets and exposures now readily and cost-effectively available, an institutional portfolio invested in the U.S. only is inefficient, accepting greater risk, lower returns or both.



Investments can be implemented in several ways: direct purchase of securities, mutual funds, ETFs, annuities, private partnerships. Each vehicle has its own cost-transparency-liquidity-scale-workload tradeoffs. Some are definitely better than others.


Home Country Bias

Many portfolios maintain a strong home country bias, probably just a function of familiarity and inertia. Capital markets are global and disregarding market exposures outside the U.S. is a mistake. (See above)


Active-Passive Management

Although the investment and mutual fund industry was founded and matured primarily providing actively managed strategies (strategies that actively seek to outperform a benchmark with security research, selection and trading activity), evidence continues to prove that active management dos not provide the hoped for excess returns, after costs. In simply seeking to match their benchmark return at low cost, passively managed, index-based ETFs and mutual funds outperform the vast majority of actively managed products.


Vendor Layers

It is not uncommon for an investment program to include 3 to 5 vendors, all of whom are taking a toll out of your net return. They potentially include: custodian, ETF or mutual fund sponsor, separate account manager, managed ETF strategist, Turnkey Asset Management Program (TAMP) platform, home office, advisor or broker, advisor or brokers firm, investment consultant, placement agents, fund of funds.


The aggregate expense burden can easily add up to more than 3.0% annually. Remember, that 3.0% is coming out of your gross return. Are you getting value for your investment program and results you are achieving?


How many layers are between you and your investment returns?




Portfolio Theory, Market Environment & Governance

There IS an Optimal Portfolio and services model for your unique goals, objectives and constraints.


Market Environment

Interest rates have recently up-ticked off of thirty-year lows. Equity markets have had an extended rally roughly corresponding to the secular decline in interest rates—despite two nerve-rattling market meltdowns. It is probable that forward returns will be muted relative to historic returns. If your expense burden is a fixed cost, it is likely to consume a larger portion of your gross return in the coming years. Is that ok with you?


Diversification & Asset Allocation

Diversification is the free lunch in investing, virtually eliminating company specific risk. Asset allocations should now include global capital markets (stocks, bonds, preferreds, and real estate at a minimum). Some direct investment in the private markets can make sense. Venture capital offers outsized returns. These last two investments often require large capital investments and that investors accept significant illiquidity. They make most sense for institutions and large private investors.


Fiduciary Responsibility

It is not too well-known that some investment professionals accept fiduciary responsibility while some do not. Fiduciary responsibility is simply the duty to put client interests first and foremost. The logical inference for someone who does not accept that responsibility is that sometimes they prefer to put their own interests above yours. If you work with an investment professional to advise you, does it make sense to trust advice from someone who does not put your interest first? You already know the answer to that.


“If revenues fail to exceed expenses, no organization— even the most noble of faith-based institutions—can long survive.”

The issue is not choosing between professional values and business values. Rather, it is balancing that ever-competing pair in a way that places the best interests of consumers and clients above our own corporate and personal interests.”

John C. Bogle

Balancing Professional Value and Business Values

Financial Analysts Journal | 2Q-2017


The first quote is a truism. The second is an ethical standard for those who consider themselves true investment professionals.


And you have choices to make. An investment program that is too expensive is either extracting unfair economics from you as client or they have an unjustifiable cost structure. Either way, you pay the price with lower net returns.


What is YOUR Answer?

My basketball coaching mentor was fond of saying, “there is always an answer.” Whatever your opponent was trying to do, there was always a way to counter, check or otherwise thwart their effort. You just have to know what the answer is. And the team needs to know how to execute it.


The same is true for investment programs. There is always an optimal service model to engage and an optimally efficient portfolio for your unique goals and objectives. You just have to know that it is, or who to engage for investment advice to deliver it at the best cost.


For an individual investor a better outcome could mean a better quality of life with more security in retirement. For an institutional investor a better outcome could mean better current benefit payouts or greater current spending capacity to fund organization programs.

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