Warning: private banking injures your wealthPosted: 2016-09-11
Picture the scene. You’re an entrepreneur / widow / recent inheritor / recent divorcee or similar. You don’t work in financial services. You find yourself receiving a lump sum of cash – more than you have any immediate plans for – and, as surely as a carcass on the African plains attracts vultures, you end up talking to a private banker or an independent financial adviser.
If this scene is familiar to you, then I think this blog post is the most important blog post you will find on my blog.
The charming, well-dressed and thoroughly presentable financial professional makes arguments along the following lines:
- I am a very experienced financial professional. You can tell from the quality of the tea and biscuits, my dress code, and perhaps my accent – suggesting that at least my parents and grandparents had a lot of money.
- You are a talented and clever person. Either because you created value some of which you have just ‘cashed out’, or because you married a very talented/rich person who sadly(/happily?) is no longer with us and/or you.
- You realise that leaving your money in cash gets it nowhere, before tax.
- You understand that all the rich people do not just leave their wealth in cash but instead have their money ‘invested’. I invite you to believe that this has helped them to protect, maintain and increase their wealth.
- There are a lot of clever things you can do about tax. [For the purposes of this blog post I am not going to expand on this further].
- You do not have the time and/or expertise to manage your money yourself. Picking stocks is gambling, complicated and your money can be at risk.
- I and my firm manage money for a living (therein lies a clue which I don’t want you to dwell on, and heaven forbid don’t ask what I do with my own money).
- In fact at my firm we can do various particular things for you:
- We have many clever analysts. I can introduce you to some and ensure you have ready access to them whenever you want it.
- We have economies of scale which allows us to negotiate better rates than you or our lesser rivals can get.
- We can invest in overseas investments.
- We have access to special investments that aren’t generally available. These include investment products made by some of the most famous and successful financial services firms of all time, who do not deal with mere mortals such as you.
- We, or some of our most trusted friends, can structure special products which
turn base metals into goldeliminate all risk and practically guarantee fantastic returns.
- We can look after whatever tax filings you need in whatever jurisdictions / etc your tax planning / divorce court / similar lands you in.
- We will review your finances carefully against your objectives and give you professional, bespoke advice – a complete financial strategy, along with all the help you need to execute it.
- Fees? Well, since you ask, yes there are some fees but they are very modest. Essentially only just 1% of all that money we manage for you, along perhaps with occasional incidental expenses.
I invite comments about how well I have captured the thrust of a typical IFA/wealth manager’s pitch. I have quite a bit of experience of being on the receiving end here and think I have captured the key pitch; indeed, I would even say that it does sound quite compelling.
I myself took the bait about 15 years ago. I have had a pot of money managed by a private bank since around 2000. I did so as part of a ‘test and learn’ strategy in which I put various pots of money to work in various places – some went to private banks, some I managed myself, some went into structures I found with an IFA. I tracked all of it quite carefully with some professional investment-tracking software (alas that is no longer on the market). Since 2013 I have been more rigorous and have done full month-end tracking which I post on this blog, but I have most of my portfolio tracked pretty accurately (albeit updated sporadically, not monthly) since around 2000.
What I gradually learnt from 2000 to 2010 was that the money I managed myself did better than the money I invested with the professionals. I didn’t really think about why this was – other than my ineffable genius – but it was pretty clear that fees were a part of it. Gradually I moved more and more of my money into pots that I manage myself, leaving the pot managed by the private bank as a smaller and smaller proportion of my net worth.
In the last few years I have become increasingly maniacal about fees. Yet even as I did so I continued to pay my private bank 1% to manage a large balanced investment portfolio. I reasoned that this was the ‘entry ticket’ into that relationship; the private bankers gave me decent service (at a transactional level) and that the 1% fee, when viewed across my entire portfolio (most of which has <0.1% fees), wasn’t an unreasonable fee to pay. My blended expense ratio was well under 1%, or so I thought.
In any case, with the recent FT article about fund managers making 2.5% per year on typical portfolios, I wondered ‘who are the idiots who are paying 2.5% per year?’. And this got me looking more carefully at my own situation. And lo and behold, my ‘1%’ figure turns out to drastically underestimate the fees I’m paying. I discovered I myself am one of the idiots.
The true figure I am paying my private bank, for a ‘discretionary portfolio’ they manage for me, is a gob-smacking 2.04%. This probably excludes a few trading fees within some of the funds that I can’t cleanly see. How do I get from ‘1% of money managed’ to ‘2.04%’? Only by being an idiot.
Here is what is happening:
- The price has gone up. I didn’t realise but at some point in the last few years my annual service fee has increased to somewhere around 1.2%. I don’t get clear invoices for this so I haven’t quite got to the bottom of it.
- VAT. The 1% – sorry, 1.2% – is a service fee. And services attract VAT. 20% in fact. So the supposed 1%, which I now realise is 1.2%, is actually 1.44% straight out.
- The portfolio contains fee-paying funds and ETFs. The structure of the portfolio is shown below. As you can see, funds account for over 50% of the value of the portfolio and the total expenses of these funds amounts to 30% of my expenses – which is over 0.6% of my assets. ETFs, which are about 12% of the portfolio, also have fees but they are much lower – amounting to 2.4% of my expenses and thus only 0.05% of my assets.
|Contents of discretionary portfolio||% of portfolio||% of fees|
|Equity – share||22.37%||0.00%|
|Equity – ETF||12.03%||2.36%|
|Bond – ETF||6.97%||0.68%|
The seven largest funds account for 30% of my portfolio and have average fees – on top of the portfolio management fee – of 1.1%. Take a look at the list below: would you pay 1.44% to be placed into these funds?
|Security||Total Expense Rate %||% of portfolio|
|Blackrock European Dynamic Fund||0.92%||6.6%|
|Polar Capital Funds Plc – Global Technology Class||1.15%||5.4%|
|Findlay Park Funds Plc – American Fund||1.04%||5.3%|
|Standard Life Investments – UK Smaller Companies Fund||0.99%||4.0%|
|J O Hambro Capital Mgmt Umbrella Fund- UK Equity Income Fund||0.69%||3.4%|
|GS Quanto Autocallable Note on SPX, Sx5e, UKX, 22 Apr 21 Sn025-16||est. 2.00%||3.0%|
|Barclays Globalaccess – US Small & Mid Cap Equity Fund||1.00%||3.0%|
So, having established I’m overpaying savagely for a fund-of-funds, how is the performance of this portfolio doing?
I’ve pulled out the performance of my private banking discretionary portfolio over the last 15 years. I’ve done the same with a small portfolio that I’ve had with Fidelity throughout that period (for which, these days, I pay a platform fee of about 0.3% plus the TERs of the actual funds; my blended cost is about 1.6%). And the same for a portfolio I’ve managed myself, on a low-cost internet broker, since 2000; this portfolio is mostly UK equities but with a few UK funds in there too (this portfolio has no annual fees; my blended costs are less than 0.3%). For all three portfolios I am looking at the year-end net portfolio value, after fees. The results are shown in the figure below.
What you see is that my own portfolio has been averaging about 2.5x the annual net performance of the private banking portfolio. The Fidelity portfolio is pretty neatly in the middle, and very closely (did I say closet-ly?) tracks the FTSE-100’s performance. The private banking portfolio has delivered only two thirds of the FTSE-100. These figures ignore taxes and inflation; after tax, my private banking portfolio has not kept pace with inflation.
The private bank’s 2.04% fee is clearly a major part of this underperformance, but not all of it. It is important when comparing two or more portfolio track records to adjust for relative risk. A portfolio comprised purely of tech stocks might outperform a steady bond portfolio, but it is also far more volatile. An easy way of normalising for this is to look at the Sharpe ratio, which is the ratio between the return and the volatility. On this basis, the portfolio I’ve managed and the portfolio Fidelity has managed are almost identical; but the private banking portfolio is a third worse.
Overall, fact Fidelity has a reasonably good argument for its fees in my view. It hasn’t underperformed the market, but it has delivered similar performance after fees with noticeably less volatility. I recommend Fidelity to family and friends as a sensible place to invest in the stock market if you can’t face doing it yourself. However its Sharpe ratio isn’t better than my own, and the performance gap versus my own funds is almost exactly the blended fee of 1.6% p.a.
The private banking portfolio, on the other hand, is a clear rip-off. In its defence, it clearly is a lower risk portfolio than the others. I was particularly appreciative of this in 2008 when it dropped by ‘only’ 12%, compared to the 32% wound I was nursing in my own portfolio. But actually the performance back in 2000-2002 was worse, with an 18% fall top to bottom. And when you look at the graph those bigger dips on the less expensive portfolios only brought me down to the level the private bank had struggled to reach in the first place. I can’t recommend private banking portfolios to anybody.
In case you’re wondering whether my particular private banking portfolio is a lemon, I don’t think it is. I’ve had three such portfolios over the years. The surviving one has survived because it is the least bad. Investments I made through my IFA have done worse but are so illiquid I can’t even get out of them properly. And I’ve been pitched others’ solutions too and don’t believe anybody has a structural advantage over my private bank. I’m not naming my bank because I think their rivals are worse, and it wouldn’t be fair to my lot to imply they are uniquely dreadful. London Rob’s IFA seems better but is still underperforming London Rob himself.
The lessons here are clear: avoid paying 1%+ of your assets to a middleman. Especially if that middleman then invests in a bunch of managed funds, which just adds fees upon fees. This means you should:
- Ideally, manage your money yourself. See Monevator’s excellent blog for guidance.
- If you can’t/won’t do that, then open a diversified investment portfolio with Fidelity (or Hargreaves Lansdowne, or similar) and pick a handful of their lowest-cost equity-orientated funds. Or go for a Vanguard Lifestrategy fund (which is not quite as easy as it sounds to set up, I think).
- Use IFAs for specific tasks such as setting up a portfolio, tax structuring, dealing with a health situation. But in all cases avoid paying any ongoing fees. What you really want from an IFA is a single page recommendation of how to structure your funds, and what to allocate to whom. Do not let the IFA then implement it for you – go and do it yourself. By all means pay the IFA for the consultation but let that be it.
- Use private banks, if you must, only for transactional accounts and not for any investment portfolios.
And I myself need to stop paying my private bank a ridiculous sum for such terrible performance. I don’t want to close down the relationship entirely so I need to tread carefully. Any tips/suggestions for how to do this would be much appreciated.