Scientists often use every day analogies to explain complicated scientific concepts. For example, Einstein’s E=MC2 tells us that there’s enough energy in the mass of a sultana, assuming you could harness it, to power New York for a day. Or the fact that the nucleus of an atom represents more than 99.9% of its mass, but if you enlarged an atom to be the size of the Melbourne Cricket Ground, the nucleus would still only be the size of a pea.
These analogies are useful. But the best tip I received about trying to understand the Theory of Relativity or Quantum Mechanics is to accept that your brain is not built to comprehend them.
Just as your eye only responds to the small percentage of the electromagnetic spectrum that you need to navigate the world around you (the only difference between the visible light spectrum and microwaves, radio waves and x-rays is the wavelength), your brain only comprehends speeds and sizes that you need for everyday life. When you start talking about the speed of light, the size of the universe or the probabilistic behaviour of an electron cloud, these concepts are outside our brain’s spectrum. They’re no less real. It’s just that we don’t need them to navigate the world in which we live.
Which brings me to a problem I have with fee disclosure. ASIC has done a great job of standardising Product Disclosure Statements (PDSs) so that fund managers need to include a standard table of fees. This table must include examples and is supposed to make a comparison of funds a straightforward exercise.
But to the human brain, 1% and 2% are both minuscule numbers. Expressed as a percentage of assets, the fees seem small and the difference between two small numbers doesn’t seem particularly relevant.
Industry super funds have done a great job of showing how much difference these small numbers can make to your long term returns. But when you’re reading through a PDS and comparing it with a similar fund, most of us see 1% for one fund and 1.8% for another and think ‘well, the performance is going to be far more important than one or two percent’.
What I’d suggest is reframing those fees, not in terms of the total asset base but as a percentage of the expected return. Of course, expected return is a wobbly number, but ASIC could set some straightforward numbers to use as examples. Or it could make managers provide a range. So you would end up with a table which has fund returns from, say, 6% to 12% down one side, and the percentage of that return that goes to the manager down the other side.
Instead of forcing a fund manager charging 2% per annum to provide an example stating ‘if your average balance is $50,000 dollars, you’ll pay $1,000 per annum in fees’, ASIC could force them to say, ‘if this investment returns 10% per annum, the annual management fee will be 20% of your returns’.
When faced with the prospect of one manager taking 20% of their expected returns and the other 10%, retail investors might give the issue a lot more attention.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.