The following investment fee overview is designed to help your organization ask more informed questions as part of your investment decision-making process.
1. Advisory fees
Investment management fees are partially driven by the level of service provided. A full-service Outsourced Chief Investment Officer (OCIO) solution where the investment provider acts in a fiduciary capacity will typically include:
- Investment policy review and development
- Asset allocation modeling
- Manager research and due diligence
- Fiduciary portfolio management
- Customized performance reporting
- Independent peer ranking
- In-person presentations
- Strategic planning, consultative advice, and thought leadership materials
- Custody and safe keeping of assets
Independent, conflict-free OCIOs that don’t offer proprietary products will generate most of their compensation in the form of an investment advisory fee. That fee, though, will likely vary based on the investment strategy. Long-term portfolios with a mix of fixed income, equities, and possibly alternative investments tend to carry the highest price tag. Intermediate portfolios with fixed income assets greater than 12 months are generally a mid-priced solution. And short duration and liquidity portfolios tend to be the least expensive—but also usually generate the lowest return.
Investment advisory fees are a fee for service that covers the advice of the advisor and the research of the firm. They don’t include the fees paid to mutual funds or separate account managers to execute the particular strategies. If the assets are on a fiduciary platform, however, there typically won’t be any transaction fees added to the advisory fee.
Alternatives to an OCIO model
Instead of a full-service, OCIO solution, your board may only require a degree of investment consulting services. Consultants offer advice on investment strategy, but don’t assume any fiduciary responsibility for actual decision making. Their service can range from a full-service consulting solution that includes most of the OCIO services (with the exception of fiduciary decision making) to a partial solution that covers recommendations for a specific single asset class.
How are advisory fees charged?
Investment advisory fees can be charged in a variety of ways. They can be assessed on the net asset balance in the account, a flat, negotiated rate, or a tiered rate with breakpoints based on asset values. Most investment firms have minimum fees that must be met in order to use their services. And these fees can either be billed or withdrawn from the account on a monthly, quarterly, or annual basis.
2. Fund fees
Mutual fund and manager fees
For OCIO providers, the investment advisory fee reflects the assumption of fiduciary responsibility by the advisor. Unless the investment solution is proprietary or run ‘in-house’ by the investment advisor, however, an investment vehicle such as a mutual fund, separate account, or partnership will be necessary to implement the strategy. This will involve fund fees (also known as expense ratios or operating expenses).
These fees apply to all classes of investments and generally increase in both amount and complexity for alternative strategies.
- Active strategies, where the fund company is employing a distinct approach in order to exceed market returns, typically charge higher fees.
- Passive strategies, which replicate the holdings of an index, tend to charge much lower fees.
For this reason, some organizations opt to employ low-cost, passive strategies in asset classes that are considered ‘efficient’—where active managers haven’t demonstrated a consistent ability to outperform their benchmarks.
Mutual fund and partnership fees are embedded in their returns. While detailed in the fund’s disclosure materials, they don’t appear as a line item on accounting statements.
Alternatively, some organizations use separate accounts (aka separately managed accounts, unified managed accounts or wrap accounts) to implement their strategies. Managers of these accounts implement specific strategies using a portfolio of individually managed securities. Often, they will have thousands of accounts based on the same strategy and manage each one in a highly consistent manner. Separate accounts typically require significant minimums and charge fees directly to the account (or an assigned account).
Regardless of which type of fund your organization’s assets are invested in, the share class should be institutional rather than retail. Institutional share classes offer negotiated discounted access to funds for their larger clients, may require higher minimum levels of investment, and usually operate with a lower overall expense ratio than retail funds.
While mutual funds and separate accounts charge a single fee as a percentage of the net assets that they manage, alternative investment or hedge fund fees are more complex. Hedge funds often charge a management fee and a performance fee. Similar to other types of funds, hedge fund management fees are calculated as a percentage of the fund’s net asset value.
These typically range from 1% to 4% annually, with 2% being standard—although the recent trend has been towards lower fees (1.4%). Performance fees, which are calculated as a percentage of the profits gained by the fund, can be as high as 40% but have traditionally averaged around 20% (with ongoing fee pressure reducing that to 16%).1 To further complicate the calculation, hedge funds can also include a preferred rate which serves as a ‘hurdle rate of return’ that the fund must meet before assessing any performance fees.
Fund of fund strategies combine a number of different hedge funds within an umbrella-like structure to provide professional selection of managers, oversight, and a higher level of diversification compared to individual hedge fund investments. These typically carry a management fee and potentially a performance fee at the fund of funds level, as well as at the underlying hedge fund level. So investors should read the disclosure materials carefully.
3. Indirect fees
In addition to fund fees, some funds charge a variety of indirect fees—although typically these indirect fees don’t apply to institutional fiduciary managed accounts. One such fee is the ‘soft dollar’ payments to brokerage and advisory firms. Fund managers do this by executing trades in a specified amount in exchange for research. This payment is passed along to investors in the form of trading costs where a portion of the per share expense is allocated to soft dollar rebates.
The inherent challenges with these soft dollar fees is that they’re built into the cost of trades, and not disclosed to the investor. If research fees were directly paid to brokerage firms, they’d be disclosed in the management fee. While all costs associated with a fund are borne by the investor, embedding soft dollar cost into transactional fees makes comparative cost analysis challenging when selecting a fund. The best way to determine if soft dollar fees are paid to your advisor is to ask, or review fee disclosures.
Another common indirect fee is the 12b-1 fee. While not typically charged to institutional share class funds, these fees allow fund companies to act as their own distributors. The 12b-1 fee is typically paid as a sales commission to the advisor recommending the fund. Originally, this fee was a marketing expense designed to attract assets to improve economies of scale. Advisors should disclose the level of 12b-1 fees they receive as a result of their recommendations to avoid obscuring the total level of fee income they receive from a particular client relationship.
Some brokers also use a technique called revenue sharing. This is direct compensation paid to the broker from the fund distributor or advisor company (not through the fund or trading commissions). It’s based on the amount of sales and the total assets that the broker has with a fund company. Fees received are not typically rebated to the client or paid directly to the salesperson. Brokers can also charge revenue sharing fees to mutual funds for inclusion in researched models or availability on their platform. Revenue sharing, in particular, may create a conflict of interest between investors and brokers due to the financial incentive tied to funds with high levels of revenue sharing.
Finally, non-cash compensation paid by mutual fund distributors and/or advisors for mutual funds available on the broker or investment manager’s platform may contribute funds to support education programs. Training and education expenses vary by vendor and event. A vendor’s sponsorship of advisor education could influence an advisor’s recommendation regarding specific products and services.
4. Transaction fees
Brokerage firms and investment advisors often require a commission (also known as a transaction fee or load) to buy and sell a mutual fund. A front-end load is charged at the time of initial purchase and is deducted from the total investment, netting a lower initial purchase. A back-end load or deferred sales charge is charged at the time a mutual fund is sold. It can be a flat fee or it can decrease over time as a retention strategy. Front and back-end loads often vary by share class. For institutional investors in a discretionary relationship, mutual fund loads are not typically charged.
5. Administrative fees
In addition to advisory, fund, indirect, and transaction fees, some organizations pay for a wide variety of additional services including:
- Gift clearing—a fee to accept stock gifts into the account and hold or sell and transfer the assets. This fee is generally charged per asset; and there may be an additional per account fee.
- Trustee services—a fee to serve as a trustee on a fiduciary account. It’s most often charged as a percentage of net assets and varies by the extent of duties performed.
- Fund accounting—a fee charged to provide detailed fund sub-accounting and/or participant statements. It’s charged for the overall service, but the amount will vary based on complexity, number of funds, and participant reports.
- Tax services—a variable fee charged to prepare tax related documents and filings.
- Planned giving—a fee charged to administer planned giving assets (charitable gift annuities, charitable lead trusts, charitable remainder trusts, and pooled income funds). This fee will also vary based on the extent of services provided.
- Base account fee—a fee charged per account for additional accounts in a relationship. This typically applies to custody only.
Value. Worth. Fairness.
Fees are a fundamental component of investment management services. But those fees must be reasonable, transparent, and fully disclosed. For any fiduciary, a thorough understanding of the fee structures within an investment portfolio is an essential part of your duties.
While the industry-wide push towards lower fees is a positive thing, higher fees can sometimes be justified—when accompanied by a commensurate levels of service, assumption of fiduciary responsibility, and improved investment results. It’s up to your investment committee to decide whether the lowest fee vehicle is also the choice that can deliver the most competitive returns over an entire market cycle in every asset class.
A thoughtful analysis of fees will include a parallel analysis of the level of service provided and investment acumen resourced in exchange for those fees—as value received and delivered should be the key metric in any assessment of investment service providers.
About Truist Foundations and Endowments Specialty Practice
Truist has more than a century of experience working with not-for-profit organizations. Fiduciary stewardship is the heart of our culture. We’re not just a provider, but an invested partner—sharing responsibility for prudent management of not-for-profit assets. Our client commitment, not-for-profit experience, and fiduciary culture are significant advantages for our clients and set us apart. The Foundations and Endowments Specialty Practice works exclusively with not-for- profit organizations. Our institutional teams include professionals with extensive not-for-profit expertise. These professionals are actively engaged in the not-for profit community and are able to share best practices that are meaningful to their clients. Team members offer guidance and advice tailored to the various subsets of the not-for-profit community, including trade associations and membership organizations. Our Practice delivers comprehensive investment advisory, administration, planned giving, custody, trust and fiduciary services to trade associations, educational institutions, foundations, endowments and other not-for profit clients across the country.