The ABCs of Fees
How to Choose the Right Asset Manager and Fee Structure for Your Offshore Account
Over the past 20 years, capital markets outside the U.S. have grown rapidly in size and importance. In 1970, non-U.S. stocks accounted for 34% of the world's US$935 billion total market capitalization.
Today, international trading accounts for a full 57% of the world's total stock market capitalization, with the U.S. commanding just 43%. The sad part of this story is that many U.S. investors aren't taking full advantage of the rich profit potential in offshore markets. According to a recent survey, just 13% of Americans currently invest internationally, and only 19% plan to do so over the next five years.
I find that incredible considering international stocks have outperformed the S&P 500 Index by nearly 3-to-1 since 2003. Emerging markets returns have been nearly six times higher than the S&P 500 over the same period!
Make Your Money Last - for Decades
When it comes to international investing, you have more than your fair share of choices. Yes, most of us don't have the time, or the inclination, to manage our own portfolios. But, we do have a clear idea of what we expect from our money - we want it to last. That's why the best solution is often to hire an investment manager who can navigate the markets for you.
But before you sign the management agreement, it's important you understand how your potential manager will charge for performance. You also need to
know about additional offshore bank fees that might come into play.
There are multiple ways that independent asset managers structure their fees. At first blush, the fee structures may look similar. But there are actually subtle, yet important, differences. Let's take a closer look.
Why Fees Are Nothing to Sneeze At
A Flat 1% Fee: An annual management fee of 1% of the managed assets is the most common fee structure. Managers take this fee directly from your account on a monthly or quarterly basis. Of course, if your account is in the seven figures, you have some room to negotiate. Most asset managers will lower their annual fee by 0.20% to 0.25% for accounts over US$3 million. Other managers will start to decrease their fees with accounts worth US$1 million or more.
A flat fee is one of the most common fee structures because your manager is rewarded when you make money. Your manager's income also goes down when you lose money. Many people in the business feel this is one of the fairest ways to work with clients.
A Flat Annual Fee with an Incentive Bonus: The idea behind this type of arrangement is that your manager is rewarded for exceeding your expected profit target. If you work with a more aggressive money manager - namely one who uses alternative investments such as hedge funds - to produce their annual returns, your fee schedule may be enhanced. If you choose this arrangement, your investment manager takes a flat fee between 0.75-1%.
Plus, your manager also takes an incentive fee of 15-20% the minute he or she earns a net profit after deducting all the other fees. Keep in mind that if your incentive fee-based advisor suffers a drawdown, your manager can only collect incentive fees again after reaching a new all-time high for your portfolio.
Some incentive managers take a flat fee plus an incentive fee that kicks in when the investment gains reach a pre-determined level. This is also known as a "hurdle level." For example, your asset manager could take an incentive fee of 15-20% over a pre-determined hurdle such as LIBOR (London Interbank Offered Rate) or the S&P 500.
A Higher Flat Fee with Commission Rebates: Reporting requirements around the globe are becoming more and more transparent. Now, some international money managers are charging a slightly higher flat fee of 1.25% to 1.5%. They're offsetting this higher fee by crediting bank fees directly back to the client.
For example, the average offshore investment account holder pays about 0.75% to 1% in bank fees for custodian services and sales commissions when the account buys or sells stocks. These are additional fees on top of the fees already paid to the asset manager. Some banks offer fee rebates to the asset managers. The rebates are anywhere between 25-50% of the fees charged.
While some asset managers take the fees to help offset their direct costs and to keep their management fees low, other managers give those rebates directly to the client.
Truth be told, it's almost a wash. You can pay a higher management fee and recoup some of the expense by receiving the bank rebates. Or you can pay a lower management fee and give up any possible rebate that might be offered.
A Few Extra Bonuses
In addition to managing your wealth, there are few extras that asset managers can offer. Regardless of which asset manager you choose, you must hold your money in a bank account. In some cases, your manager can negotiate a lower custodian fee on your behalf, if he or she works exclusively with only one or two offshore banks. For example, if the bank charges an annual custodian fee of 0.5%, your money manager might be able to negotiate to have that fee reduced by 50%.
In addition to lower custodian fees, some managers receive a discount on trade commissions. This means it's cheaper for the manager to buy and sell stocks than if you bought or sold them yourself. Again, the fee reduction is about 0.2- 0.3% but it can add up.
Make Sure You're Comfortable with Your Choice
Some members have told me they don't want to hire an offshore asset manager because they aren't comfortable handing over control of their money to a third party. In my opinion, you should never give control of your money to someone you don't feel 100% comfortable with. There are at nearly 10 different asset managers that we are associated with, not to mention the money managers that work with our banking partners.
Invest time so you can properly interview money managers about their investment philosophies. Find out what type of average returns they shoot for and do they use traditional investments or alternative ones. Will they call you or email you quarterly? And, of course, inquire about their annual fee structure as well as any banking fees associated with the account. Being an educated client isn't difficult and it's in your best interest as well as theirs.
(Reprinted with permission from The Sovereign Society.)
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