Several layers of fees, including hidden ones, are common practice in banks' portfolio management. Over the years, this eats into investment returns. Independent experts are key to helping investors identify what banks really charge.
Do investors really know how much fees they pay in total? Banks charge entry fees (5%), management fees (2%), performance fees (20%), fund manager fees and upfront administrative fees. These multiple layers of fees don’t show on your typical portfolio management contract.
A private bank will display management fees of usually 0,75% or 1%. But it will actually charge at least 1,5% to 2% on a client account, all included. «What you end up paying can be double of what you think you’re paying, sometimes more», says Daniel Pinto, founder of Stanhope Capital, a London-based multi-family office that is one of Europe’s biggest independent asset managers, with $26 bn in managed assets.
A fact confirmed by Adam Said, founder of Ace & Co, a Geneva-based private equity firm with $1.5 bn in assets. «Announced fees are 0,75 to 1%, when in reality it can be 1,5 to 2%».
This naturally eats away a good chunk of net returns. «Taking a 2% fee on assets that are low risk and hardly returning 5 to 6% is huge», says Daniel Pinto.
«If you add up custody, administration and portfolio management fees, and you include the fees charged by the underlying funds, you find out that 50% of total fees are not included in the costs disclosed by the bank», says Bruno Gillet, expert at CAPAnalysis, a company active in portfolio monitoring.
He also cites a typical mandate where only 0,85% fees are disclosed to the client. But if mutual funds are included, fees reach double that percentage. Administration fees can also be heavy. In some private banks, the opening of an account is charged at 2500 Swiss Francs, even though this task is highly computerized.
Calculating the actual total fees paid by clients can require lots of expertise and some reverse engineering. Structured products are the most fee-laden vehicle. Experts calculate the real total charged to the client by taking the raw performance and subtracting the net performance: if the coupon generated 11,5% before fees, and 8,5% net of fees, it means 3% were collected. Entry fees and internal margins make up a good share of it.
Estimating the bank’s margin requires a recalculation of the cost of the underlying option at the conditions prevailing on the day of issue, without the bank’s spread and markup. The bank’s margin is made by selling volatility to the client, and earning the spread between it and the realized volatility. A «reverse convertible» containing only safe blue chips, but charging 2,5%, isn’t fair. The fee is too high compared to the client's potential gain and actual risk. These products' assumed volatility isn't disclosed to the client.
Things are easier for institutional buyers, who can require three or four offers from different counterparties. Private clients cannot play the competition. The distribution of these products can also be a fee-trap. The profit allocation between the issuer, institutional buyers and final clients is often done at the expense of the latter. «Besides, option calculators can even include the fees upfront instead of providing you the raw market return», warns Bruno Gillet.
Forex transactions have hidden fees as well. The CAPAnalysis expert recalculates the spreads on currencies by comparing them to the day’s range (high/low). «If a dollar-euro transaction has a small market spread of 10 pips (or 0,1%) and the client has actually paid 1,5%, he needs to be aware of that.» Multiplying transactions to cash in fees is tempting. Gillet recalls having seen «funds transactions in discretionary mandates where the bank is buying USD against CHF, and reverting back, on a single day».
Hidden fees are a way for institutions to make up for the lost profitability in wealth management after the new Swiss transparency regulations, the end of banking secrecy and the end of kickbacks since 2012.
However, clients ought to care about their costs, according to experts. Over the long term, «managing to save 0,5% to 1% in fees each year is huge, because of compounded returns», says Jean-Sylvain Perrig, founder of Premyss, and independent advisory firm. «This can justify the several thousand francs a year that an independent expert will cost you». The costs of such an expertise and a follow-up make more sense for portfolios above 10 million Francs, he adds.
Experts consider family offices and pure plays to be the most independent. Both Stanhope Capital and Ace & Co are fully transparent and aligned with their clients, with partners investing in the same products at the same conditions, with no cumulative fees.
«At Ace & Co, we chase returns, not fees», says Adam Said, whose direct play into private equity spares clients several intermediate layers of fees. «A private client needs to look for the most direct route to investments», he says, adding that the disintermediation trend will benefit the end client, including retail investors who can now access a wider spectrum of asset classes (including private equity) with less intermediaries in the middle.