You know the concept: you have some Cash saved up, you give it to one of the Trend Following Wizards, they give you a very decent return over the long run and take their share of the cake in return for it: EVERYBODY’s HAPPY!
Let’s explore the impact of fees charged by Fund Managers on the overall long-term return on your money. This is a question you might want to ask yourself before venturing in building automated trading systems (i.e. from a business point of view: would I spend a large number of man-days building a system that might barely achieve a better return than an established and succesful fund manager).
The assumption is that Trend Followers exhibit similar performance (for similar leverage). This can be verified when looking at the historical performance of the wizards. That can be explained by the fact that there is no “rocket science” approach to trend following. It boils down to getting on the trend as it starts and riding it until the end (when it bends…). For a given timeframe, any indicator you use would most likely identify the same trends.
To simplify, we will assume that a trend following fund manager achieves 20% per year and charges 1/20 fees (1% of AUM and 20% of performance).
Is it worth investing many hours in building a system yourself – or are you better off sending a cheque to John Henry, Dave Harding or Ed Seykota?
A gross return of 20%, after fees of 1% and 20% gives a net return of 0.99 x (20% x 0.8) = 14.84%
Turns out to be quite a difference!
By extrapolating and running a year by year comparison of gross return vs. net return we can see how the difference stacks up:
|NET RETURN||GROSS RETURN|
Net vs. Gross Return Comparison with starting capital of 100
Assuming that you have managed to build a system that produces the gross return above, we can see that keeping the fees for yourself (ie running the system) has quite an effect on the long-term return on your capital (compared to getting a fund to manage your capital):
After 3 years, you would already have gained one year compared to the managed fund approach (i.e. same capital but a year earlier). After 13 years, you are 4 years ahead!
And this is without considering you now have the option of raising external money to manage and earn your own fees (which you can only do if you run your own system)!
The example above illustrates the power of compounding and how small differences can end up making big numbers – which justifies putting the efforts to manage your own capital.