Investment Risk, Return and Fees…as a guide to investment decision-making

Considering the substantial increase in financial services delivery in areas of investment products, customer service etc., the investor vis-à-vis his investment objectives is always faced with a dilemma as to which investment manager to choose, which product to invest in, how long to commit to an investment.  In this piece, we will seek to advise readers on factors you cannot afford to take for granted before making an investment decision.

Typically, we tend to buy investments for their performance – but that is not the only thing to focus on. How well an investment fund or portfolio performs hinges on but is not limited to risks taken, investment costs incurred and returns earned. As an investor you have least control over performance (return), some control over risks, and most control over costs you incur. Investment decisions are closely tied with investment risks. The decision itself is a subjective act, but it is based on both subjective and objective factors.

Investment risks

Investors seek to make the most money with the least risk. It is however necessary to factor-in the risks associated with a particular investment before making a decision. Risks are usually scenario-dependent – what an investor would consider risky depends on the requirements and constraints presented by that investor’s situation.

In an investment decision, risks facing the investor include Liquidity risk (the possibility the investor may not be able to convert his assets into cash as and when desired); Market risk (risks that affect all investments and its undiversifiable in nature), Interest rate risk, inflation risks among others.  An investor in a decision-making process does not have enough knowledge about the future outcome of events, and will have to wait to get additional information regarding the unknown future.

The investment decision-maker has to decide whether to act (invest) immediately, or wait without knowing whether the additional information will confirm the level of risk or not.  Different investments or combinations of investments have different levels of uncertainty associated with them; therefore, in choosing an investment, be mindful of its risks, frequency of the risks occurring, and the cost and consequences of them occurring.

In addition, when we invest it is the expected return along with the uncertainty in expected return that we use to gauge the appropriateness of a particular fund. Indeed, when building investment portfolios, managing risk is now often given as much importance as pursuing performance – and sometimes more. This has led to a lot of focus on both ‘asset allocation’ – which is a portfolio’s basic split between asset classes (i.e. stocks, bonds, mutual funds, hard assets and cash investments) and also ‘diversification’, which is how the portfolio spreads its investment within each of these broad categories. Owning a wide array of assets and diversifying broadly may reduce risk, but it doesn’t guarantee absence of investment losses. Analysis of risks is a difficult process sometimes; as such, individual investors who do not have the capacity to do independent assessments are advised to consult their financial adviser, who is better-positioned to assess uncertainties so as to yield optimum investment results.

Investment Return

The investment decisionmaking process in this case for a retail investor also considers investment returns. When we invest, we forfeit a valuable asset in anticipation of a benefit over and above what we put in. A return is compensation for giving up the use of your capital over a period of time. Financial assets command various degrees of return in line with their respective degrees of risk. The higher the degree of return uncertainty (risk) in a given investment, the more return we demand. For instance, one can predict the return on a Treasury bill with accuracy relative to return on a stock.

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To put this in perspective, investors have many investment funds to invest in at any point in time. Fund managers usually publish the performance of their funds as means of marketing their products. However, as an investor, it is important to note a return statistic summarise rates of return achieved by the Fund manager, estimates of risk taken, and skills deployed by the efficient use of risk and timing.

Historical returns are not a guarantee of future returns, as such historical risks and return are a guide to help form future expectations about risks, and helps to shape-up our investment or portfolio selection. In deciding where to invest your money based on published investment returns, you may want to ask and/or seek answers from the portfolio manager to the following questions:

–        How do these returns compare to those earned by the fund’s peers?

–        How do these returns compare to the fund’s benchmark or market trends?

–        How much risk was taken to achieve the returns?

–        How much value did the manager add over the benchmark?

–        How did management fees, taxes and currency fluctuations impact returns, and to what extent?

–        Relative to its peers, is there any evidence of managerial skill through investment timing?

Usually, individual and institutional investors delegate the decision-making burden to fund managers, but on their own still measure their (investment manager) performance comparative to an agreed benchmark in consonance with investment objectives. As investors our objective for capital growth, income and liquidity must be synchronised with the reality of market trends, ability to select good fund managers and the manager’s skill to outperform a set benchmark as well as choosing the ideal investment product.

Transaction Fees and Expenses

The financial services industry charges various percentages for its services against your entire investment portfolio assets, through multiple types of recurring charges each and every year. Some applicable fees in the Ghanaian market include transaction fees (Commissions, sales loads, surrender charges etc.) and ongoing fees (Investment advisory fees, annual operating expenses etc.).

Transaction fees are usually charged at the time you buy, sell or exchange an investment, and this basically affects the overall amount of your investment portfolio. Ongoing fees are recurrent in nature, and also reduce your investment balance and possibilities of you earning a return on the fee charged. Realistically, whether the value of your assets increases or declines, it has little influence on these fee arrangements.

Consequently, as long as the annual fees are less than 100% of your investment returns, it is at least possible for the nominal value of your investment funds to increase (whether the non-inflationary or real value of your assets will increase after fees, taxes, and inflation are taken into account is an additional consideration).

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In the case of mutual funds and other Exchange Traded Funds (ETFs), fund managers usually charge a percentage of the portfolio’s total assets, and therefore appear to impact indirectly on individual client’s assets.

In some cases, management fees are tied to investment management performance or investment returns. This type of compensation mechanism ensures investment manager’s commitment to your investment growth interests (if you didn’t make a return, then the fund manager does not get paid – just like you did not get paid by the markets).

The more financial markets get uncertain and volatile, the more imperative it is to drive investment costs to their barest minimum to improve long-term future value and investment performance.  As we seek the best price for any product or service, so should we be mindful of how much we are paying for investment services. Before you invest, shop around; and as you shop around, you may want to consider asking your financial advisor the following questions:

–        What are the fees related to the investment?

–        What fees will you incur when you purchase, hold or sell the investment?

–        How long do you need to hold the investment to avoid fees?

–        Are there options to negotiate fees?

–        Which other products command lower fees?

–        Are there other transaction fees not mentioned? (Account inactivity, early withdrawal, statement request?)

 

 

Concluding Thoughts

Starting today, you should focus on correcting any cost-inefficiencies associated with your current and future investment cost-practices. You can only do something about investment costs going forward. Stop giving your assets away through excessive and unwarranted recurring investment fees and expenses. Take considerable risks in line with your investment objectives; returns are indicators of performance history and do not guarantee future performance. Ask questions, seek answers and, above all, seek financial advice.

 

ABOUT OMEGA CAPITAL

Omega Capital Limited is an Investment management, private equity and investment advisory firm. The Company is authorised and regulated by the Securities and Exchange Commission of Ghana.

Contact Us

Analysts:

Nana Kumapremereh Nketiah (JP)

Bernard Boakye-Yiadom

Omega Capital Research

The Alberts, 1st Floor

No. 23 Sunyani Avenue

Kanda Estates

Accra.

Phone              +233 302 201538

Fax                   +233 302 734 745

Email               info@omegacapital.com.gh

Website           www.omegacapital.com.gh

Disclaimer

Additional information is available upon request. Information has been obtained from sources believed to be reliable, but Omega Capital Limited                           (“Omega Capital” or “The Firm”) does not warrant its completeness, accuracy or veracity. The firm is licenced and regulated by the Securities and Exchange Commission of Ghana (SEC). This material is for information purposes only and it is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and estimates herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information.

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