I travel for work. And being the OCD overachiever that I am, I have a tendency to pack too many meetings, calls, speeches, and e-mails into too little time. It’s not unusual for me to leave my home well before the crack of dawn, only to roll into a hotel room 14 hours (or more) later. Starving.
As a result, I’ve become a connoisseur of what I affectionately call the “minibar buffet.” I can reliably piece together a somewhat balanced meal from the contents of a miniature fridge and shelf of partially hydrogenated snacks. To many people the most offensive part of my in-room smorgasbord isn’t that I often count gummy bears as a vegetable (hey, they’re colorful!), it’s the cost. Minibar items have a roughly 400 percent markup. Bottled water — a palate-cleansing minibar dinner staple — has a 4,000 percent markup before it enters a hotel room. Once there, that number swells to more than 14,000 percent.
Yes, the cost is high. But to me the value — in my exhausted, hoarse, sore-footed, I’ve-been-around-people-too-much-today misanthropic posttravel state — is even higher. As consumers, we have generally come to accept that little to nothing in this life comes free or even wholesale. Wine in restaurants (and coffee from your favorite barista) is marked up about 300 percent, while designer denim goes for 260 percent over cost. Still, we splurge on a pair of 7 for All Mankind jeans, a grande mocha latte, or a nice Chianti as our inner consumer focuses on the perceived value of that item rather than the cost or margin.
Interestingly, however, investors riding the coattails of one of the top five market run-ups in history have moved in the exact opposite direction in recent years, concentrating ever more on cost and increasingly less on value. While I’ve been watching this phenomenon play out for months, it moved front and center around the New Year, based primarily on two articles.
The first featured a headline proclaiming “State Pension Fund Paid Private Equity Firms $1.5b Over 5 Years.” Intriguingly, it wasn’t until the second paragraph that one discovered that a) private equity had been the best-performing investment for the fund in question, the Massachusetts Pension Reserves Investment Management fund; and b) private equity firms generated $4.7 billion for the state’s retirees during that period.
The second article mentioned a conversation between an investor and hedge fund co-founder Craig Effron, wherein the investor suggested that frustrated pension and endowment CIOs would rather accept lower returns than pay management fees. Personally, I continue to hope that was either a heat-of-the-moment statement or a gross exaggeration, but if not — well, wow.
I get that in an era of almost unchecked gains for the equity markets, it must seem now as if making money should be, if not free, at least stupidly cheap. However, I have a few minor issues with this theory.
For one thing, I realize the S&P 500 seems somewhat infallible at the moment, having survived Brexit and Trumpit so handily, but I’m a Gen X–er and I know better. The market has melted down twice in my working life, posting two ten-year losing periods since my commencement. The run-up we’ve experienced lately is lovely, but it won’t last forever, and cheap, passive profits aren’t guaranteed.
Secondly, getting a fund manager to cut fees by 100 basis points or more will enhance returns by an equivalent amount. However, looking to higher-returning managers or asset classes, rather than lower fee structures, gives investors a lot more latitude to boost returns. For example, making 12.57 percent annualized gains from 2011 to 2015 in a low-fee S&P 500 index fund is awesome, but earning 16.2 percent during the same period (like MassPRIM did, in the example cited above) in private equity — even though you had to pay more for the privilege — is better. Manager and asset class selection still matter.
Finally, if you’ve got an asset base in the billions, even a 10-basis-point management fee can generate cash flow. But what about newer or smaller shops with low AUM? Ten basis points on $100 million is not a lot for keeping the lights on and paying for research, base salaries, administrative support, and other costs. Stifling management fees may kill innovation, niche investments, and return opportunities. Case in point: Although low-cost behemoth Vanguard raked in asset flows greater than the next ten competitors, it had zero funds that cracked the top ten in terms of 2016 performance.
So before we get tied up in what managers are being paid, perhaps it’s better to sit back with an overpriced bottle of Smartwater and look at current and potential investments to determine if, when, and how they add value. If the answer is “they don’t,” cost is immaterial. If, however, an investment does provide returns, diversification, or otherwise inaccessible niche investments, well, that should be a bit harder to put a price on.
