For most of us, understanding price is relatively straightforward, but assessing value involves a more complex approach. Investors can evaluate investment value through several measures, some more objective than others.
For shares, more objective valuation metrics include the price-to-earnings (P/E) ratio, which establishes the relationship between a share’s price and the company’s earnings; the price-to-book (P/B) ratio, which compares stock price to the company’s book value; and earnings per share (EPS), which helps determine a stock’s intrinsic value.
It’s important to recognise that investment value also depends on individuals. Everyone has a different view on what represents value. Some people are thriftier and therefore focused on achieving a lower price point. Others are happy to pay more if they believe they will get better quality. In some instances, value can be hard to quantify. For instance, an expensive bottle of wine may be seen as a waste of money by one person but good value by another – even if they have the same amount of money to spend.
Assessing fund expenses
When it comes to investing, and particularly managed funds and their expenses, it’s different. It can seem straightforward to work out if an investor in one fund has obtained a greater return than an investor in a similar product with different expense levels. But to decide whether a fund presents good value or not, it’s essential that the total expenses and what they apply to are properly understood and directly comparable – which is not always the case.
The main expense types are:
Annual management fee – this is usually quite clear-cut and is easy to compare between two funds.
Management expense ratio (MER) – this represents the management fee along with other fund expenses e.g. audit costs. Again, it’s usually straightforward to compare the MER of different funds.
Performance fee – this can be more complex. It’s often difficult to compare performance fees between funds as they rarely encompass the same information and can be structured differently.
To help with this, the indirect cost ratio (ICR) can be useful. It represents the overall cost of a fund, including the MER and any related performance fees, that have been paid during the financial year and then reported to ASIC.
In addition, investors need to consider the performance of the fund during that full financial year. The ICR may look high, but were returns strong? It would be a mistake to dismiss a fund from consideration simply because of a high ICR without also taking into account what the performance has been like.
Active v passive in volatile times
Low fees have been a key pillar of the appeal of index funds. The cap-weighted index approach has served investors in Australian and US equities very well in recent years as large-cap bank and tech shares have outperformed. At face value, such funds have delivered excellent relative value. However, when markets turn and sectors revert to more historical weightings, investors in cap-weighted index funds have no means to tactically adjust sector or stock weightings.
In such times, active managers can reassess their investment theses, manage through more volatile periods and position portfolios for optimal longer term outcomes. Arguably, here (and now) is where the value lies in an active approach. While active comes at a higher price point, investors in active funds “buy” the expertise required to manage through difficult periods.
As we know, modern portfolios build natural “flex” into their asset allocation by using a combination of passive and active fund exposures. This approach usually serves clients well in terms of both total cost and perceived value.
So yes, value is subjective, including when assessing the merits of different funds. Having clients dwell on cost alone warrants a broader discussion on what is being bought at different price points and the benefits of a diversified approach through the course of the investment cycle.
Stuart Fechner, head of research house and asset consultant relationships at Bennelong Funds Management
