Here is the third part of the “How Private Banks Make Money” series. These fees are often confused with safe custody fees, however it is a completely different kettle of fish: Portfolio Management Fees.
The client of a private bank has two options, either they make the investment decisions themselves, they have an advisor/ private banker who they consult and who makes suggestions, but it is the client who makes the final decision. Then there is the other option, when the client hands over the investment decision making process to the private bank. For this service the banks will obviously charge a fee, known as a portfolio management fee.
First the bank will make a risk profile of the client, this is to determine the right asset allocation (cash/bonds/equities/exotic fruits) for the client’s personal risk tolerance.
Private banks make much of their special superdooper-extraordinary-brilliant-tailor made for you because you are so special and unique risk profiling systems. In reality it’s just a standard form for you to fill in, which will inevitably lump you into three basic types of portfolio:
Some banks will have a few others thrown in to make them seem special, but those are just like different coloured M&Ms.
The one thing the bank will do is make it very, very difficult for you to compare their performance to their competitors. They’ll have a set of benchmarks to compare their portfolio to and I’ve seen some real corkers. They might have several different strange benchmarks that if you Google them you’ll be lucky to find them. So one piece of advice: If you can’t find the benchmarks yourself by a quick web search and there are more than a handful of them in the bank’s model portfolio, tell the bank to take a hike and take your business elsewhere. Performance comparison should be an easy thing.
Then we come to the fees. Me oh my, oh me oh my. In comparison to the benchmarks the fees will read like a management consultant's guide to accounting. The idea is to make it difficult for you to comprehend and compare.
You’ll be given a couple of choices so it all seems pretty straight forward:
All in fee (includes all fees…kind of)
Performance based fee.
All In Fee
Pretty self explanatory. You pay X amount of assets under management as a fee. This should be around 1-1.5% of assets under management (AUM). If it’s under 1% then something is fishy and not everything is being revealed to you.
The way these fees can be padded is that trading is done through the bank’s own trading desk. Which basically means the guy sitting next to your portfolio manager. Although he has lunch with you portfolio manager nearly every day and their wives are best friends, he’ll charge for the execution, and that fee is taken straight out of your portfolio.
The other thing to pad the fees with is bonds and FX. When traded through the bank’s own book they can end up taking a real big bite out of your portfolio without you being any the wiser.
Legislation is cracking down on these kinds of issues, but particularly FX is proving to be difficult. Hence you should be looking out for a lot of FX hedge positions and buying and selling of investments from one currency to another. If this is happening in your portfolio then alarm bells should be ringing.
Performance Based Fees
These normally follow a small AUM fee plus 10-20% of the performance above the benchmark (see above for how difficult it is to compare to the benchmark). Many clients believe this is the best option, but I’ve never been convinced. You’re still susceptible to the above mentioned tricks of skimming fees here and there and it is an added temptation for the portfolio manager to take on excessive risk with your money (more about that in a future blog post).
Their Party Fees
Yes there's more. On top of the bank's fees there are "third party fees" which can be anything from equity trades executed through another broker or fund commission fees. Be on the look out for these and remember to ask about them. Private bankers have a tendency to forget to mention these to you.
So there you have it with portfolio management fees.
Coming up next time: Wrappers, not the sweet candy kind of wrappers, but the other types: Offshore companies and insurance structures.
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