Guest Spot: The Three Key Costs International Investors Don’t Want To Ignore

  • Author : Emma Morgan
  • Date : 20 Aug 2020

By Emma Morgan, Portfolio Manager, Morningstar Investment Management Europe Limited

International investment funds tend to carry higher fees than similar U.K. funds. For example, Morningstar reports the average non-index global equity fund’s annual fee is 23 basis points more than that of the average U.K. equity fund. 

International investors are aware of this, of course, and are willing to take on these additional fees likely because they believe in the potential for outperformance and/or the diversifying benefits of global markets. Or, they may have a need or desire to invest in a foreign currency or currencies. We endorse this reasoning and wholeheartedly believe in investing beyond one’s home country.

However, we see three key cost issues that international investors should pay attention to and seek to mitigate to best help them achieve their financial goals. We’ll take these costs in turn.


1: Cost of strategy

As discussed, fees tend to be higher for global investment strategies, largely because of active management. This is somewhat necessary, in our view. Developed and emerging international markets are very different, and each can offer unique diversification and return potential. Buying an ETF that tracks global markets delivers exposures to all markets, but we believe a skilled active manager can outperform by selecting the best exposures within developed- and emerging-markets stocks, bonds, and currencies.

Still, lowering costs has its place. According to Morningstar’s most recent global “Mind the Gap” report, investors in lower-cost equity funds in the U.K. outperformed those in higher-cost funds by 152 bps, while lower-cost bond investors outperformed by 105 bps.1 Fees take away from returns, but this report suggests the benefits of lower costs go beyond that—that managers more disciplined with costs tend to also exhibit greater skill.

This idea may be backed by academic research. Martijn Cremers, a professor at the University of Notre Dame in the U.S., introduced in 2009 the concept of active share, which essentially measures how different a manager is from a benchmark index. In a 2016 paper, Cremers showed that funds with strong long-term investment performance had high active share and longer holding periods. Longer holding periods implies less turnover, or less trading, which should lead to lower costs, all else equal.

At Morningstar Investment Management, we seek to further lower costs in our international multi-asset portfolios by using ETFs. We do not use them as wholesale replacements for broad coverage (for reasons mentioned above) but rather use targeted ETFs for lower cost, pinpointed exposures.

For example, as valuation-driven investors, we track more than 200 share markets and more than 150 bond markets worldwide, and our capital markets research process leads to conviction scores on dozens of what we believe to be the best opportunities. These opportunities may be single-country exposures, regional sector exposures, or even single-country sectors if an ETF exists to implement that investment idea. Our portfolio-level asset allocation process balances the exposures of our active managers with our own targeted ETF exposures. In this way, we seek to boost long-term performance while actively lowering costs for investors.


2: Cost of securities, or entry price

One cost affecting long-term performance that may not be obvious to investors is the security purchase price. If investing success expressed simply is “buy low, sell high”, then the first step is to buy low. We aim to do this by studying fundamentals—namely the cash flows we might expect an investment to produce over the long haul—to estimate the fair value of an asset. We prefer to buy and hold assets whose price is below our estimate of their fair value.

We do this because our research shows that holding a portfolio of underpriced assets outperforms a portfolio of overpriced assets over the next decade. This is true across and within equities and bonds—underpriced assets tend to appreciate while overpriced ones tend to stagnate or even lose ground.

Today, we view large technology stocks—especially the behemoths in the U.S.—to be richly valued and ripe for correction. Again, this calls for discernment for investment managers. We believe pockets of the U.S. market to be attractive, but the exorbitant prices that large U.S. tech firms trade at create a cost international investors should seek to avoid, in our opinion.


3: Cost of risk—drawdown and withdrawal 

We believe attractively priced assets won’t just outperform; we believe they’re less risky, too. We define risk—as we think most investors do—as drawdown, or more simply as money lost than you can’t make back. Overpriced assets bear greater risk of loss for the investor.

Names like, Apple, Facebook, and the like seem like great companies, and they are. But we don’t believe their stocks are great any price. A historical parallel may be drawn to the “Nifty Fifty” U.S. stocks in the 1960s—once-iconic brands like Kodak, Polaroid, Xerox, and Avon. Investors found these companies “so appealing that their stocks should always be bought and never sold, regardless of price,” according to “The Nifty Fifty Re-Revisted,” a 2002 article in the Journal of Investing by Jeff Fesenmaier and Gary Smith. Yet, when a bear market hit in 1973-74, these market darlings were, in the words of a Forbes columnist, “taken out and shot one by one,” according to the authors.

Investors in international markets are burdened with the cost of risk, even when it’s ignored or never considered. Minimising the costs of risk and overpaying may be more important to long-term returns than strategy costs, but they aren’t as easy to see.

This brings me to one last point about costs, and this one’s behavioural. Investors who want to manage their portfolio themselves should try to reduce all these costs to improve their chances of reaching their financial goals. However, it’s all too easy to destroy value in one’s portfolio by chasing winners and selling after markets fall. We encourage investors to think long-term, to focus on meeting their goals rather than obsessing with quarterly benchmark performance, and to use a managed portfolio as a way to go to avoid behavioural pitfalls. Not getting your retirement portfolio right is a cost few of us can bear.

Notes to the editors

This commentary does not constitute investment, legal, tax or other advice and is supplied for information purposes only. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. Investors should be aware of the additional risk associated with funds investing in emerging or developing markets. The information, data, analyses, and opinions presented herein are provided as of the date written and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar Investment Management Europe Limited makes no warranty, express or implied regarding such information. Except as otherwise required by law, Morningstar Investment Management Europe Limited shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use.

About Morningstar Investment Management Europe Ltd

The Morningstar Investment Management group, through its investment advisory units, creates investment solutions that combine award-winning research and global resources with proprietary Morningstar data. with approximately US$205 billion in assets under advisement and management as of June 30, 2020, it provides comprehensive retirement, investment advisory, and portfolio management services for financial institutions, plan sponsors, and advisers around the world. The Morningstar Investment Management Group comprises Morningstar Inc.’s registered entities worldwide. In the UK, Morningstar Investment Management Europe Limited is authorised and regulated by the UK Financial Conduct Authority to provide services to Professional clients.

The statements and opinions expressed in the Guest Spot are those of the author and do not necessarily reflect those of Novia Financial plc or any of its employees. The company does not take any responsibility for the views of the author. Any links, web pages and documentation within the Guest Spot are provided by pages maintained by independent third parties and Novia accepts no responsibility for the availability, content or use of the information contained within them.

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