Look beyond the headline costs for model portfolios

• With a plethora of unique model portfolios available in Australia investors should consider a range of factors, including cost.
• Investors are encouraged to look beyond the headline investment management fee.
• Additional costs can vary, and can detract from investors returns.

In an environment of ongoing fee compression, model portfolio expenses are top of mind. Many investors focus on a model portfolio's investment management fee relative to similar investment styles and approaches, to determine if it is priced appropriately. This is a problem because it doesn’t incorporate the total costs associated with implementing a model portfolio. To better understand the cost of a model portfolio, we break down the total cost of ownership.

What is the investment management fee

The investment management fee can generally be broken down into two parts:

1. Weighted average management cost: is the weighted average costs of the underlying investments, such as ETFs and Managed Funds, included in the model portfolios. It is the investment manager's responsibility to understand the fee’s associated with each vehicle included in the portfolio and to manage the weighted average management costs.
2. Investment management fee: This is the fee an investment manager will charge for the ongoing investment management services related to the model portfolio. Services include rebalancing to target weights, and monitoring and responding to market changes. In recent years, competitive pressures have contributed to lower investment management fees across parts of the model portfolio market.

Where the model portfolio is implemented as a non-unitised registered managed investment scheme, for example a separately managed account, a Responsible Entity manages the scheme. In most instances the Responsible Entity will charge a fee, and this may be described as, or be recouped from, the investment management fee. The Responsible Entity can also be the administrator, and may have limited involvement in the investment management of the model portfolio, delegating these duties to an investment manager. It’s important to understand the party that benefits from the investment management fee. The product disclosure statement can provide details.

Look beyond headline costs

Investment management fees are just one component of the total cost of ownership for a model portfolio. There is a range of other costs to consider beyond this headline. The model portfolio administration cost for different asset classes and trading cost are such examples. These costs can fluctuate significantly and can potentially reduce investors' returns.

• Administration fee: Typically, Australian investors can access model portfolios through a managed account. Managed accounts are available on investment management platforms. The platform will charge an administration fee to administer the investor's managed account, often as a percentage-based fee of the model portfolio's total assets. Investors are encouraged to understand the range of administration fees as different asset classes within a model portfolio have the potential to significantly impact the total cost to the client.
• Trading cost: Depending on the size and frequency of portfolio rebalancing, trading costs can accumulate significantly and have a large impact on the total cost of ownership. Generally, a model portfolio with more underlying assets and frequent trading will have larger trading costs. Therefore, it's important to determine whether an underlying asset adds sufficient value. Be sure to ask the question – what is the optimal number of underlying vehicles to enhance expected return? In some cases, reducing the number of underlying vehicles may lower trading costs and simplify portfolio implementation. In this case less can be more! (Provided that the model portfolio remains sufficiently diversified). In addition to the number of underlying assets, an active strategy may result in more frequent trading, however, investors should assess whether the potential benefits of more frequent trading outweigh the additional costs.