Principles of Nonprofit Investment Management - Commonfund

CostsVarious changes in the investmentindustry during the postwar decadeshave helped raise the awareness ofinvestment costs. Some argue that costcontrol is the key to investment success,since in the long run no investmentcan beat the averages.Cost control lacks glamour; no oneaspires to the job. It requires detailedanalysis, review and monitoring, bothbefore selecting a manager and then onan ongoing basis. In addition to investmentmanager fees, a host of otherinvestment costs must be watched:custodial, legal, accounting, consulting,overhead. Cost increases can besurprising and difficult to restrain.Controlling the cost of investmentmanagement involves three typesof activities:◆ Diligent investigation of alternativeinvestment management candidates◆ Tough negotiation of fees◆ Efficient management of themanagement firmsYou need to look at the prospectivemanager’s portfolio turnover rate. Inother words, how much buying andselling does the manager do to achieveits results? Every transaction incurscost; good management means avoidingneedless transactions. Are the managersnegotiating the best prices fortheir investors? Are the managers’ feesand compensation structure alignedwith their investors’ interests?You need to continually ask: “Can weget the same results for less?”But keep in mind that cost reductionitself can have a cost. For instance, youdon’t want to compromise the effectivenessof your risk management forthe sake of cutting costs, or settle forless than optimal diversification. Keepthe balance.It is also important to recognize thatdifferent investment products can havesubstantially different costs and coststructures. Understanding thesedifferences is important in evaluatingthe costs. Many managers, particularlyin alternative asset classes, have a basefee, plus incentive fees which can besubstantial. Ultimately, the importantissue is total return on the asset net ofthe costs.- 27 -