Question

An asset manager follows an active international asset allocation strategy. The average execution cost for a buy or a sell order is forecasted at 0.6%. On average, the manager turns over the portfolio once a year. Various administrative costs include a custodial cost amount of 0.5% per year of assets under management. The annual management fee is 1% of assets under management. The annual expected return before costs is 14% compared to an expected return of 10% on a passive global benchmark (some global index).
1. What is the annual expected return net of execution costs?
2. What is the net annual expected return for the client?
3. Should the client expect the portfolio to outperform the global index used as a benchmark?

Answer 1

Let us assume asset under management as 100.

1) Annual Expected return net of execution costs :

The average execution cost is forecasted at 0.6% and the portfolio is turned once a year. Assuming only one transaction, on 100 the cost is 0.6. So the net asset left is 100-0.6 = 99.4.

Annual Expected return before costs is 14%. That is on 100 assets under management return is 14.  On net asset left i.e. 99.4 return will be = 99.4 *14/100 = 13.92 %

2) Net Annual Expected Return for the client.

Execution cost = 0.6 on 100

Administrative cost = 0.5 on 100

Annual Management fee = 1 on 100

So the total cost on 100 is 0.6+0.5+1 = 2.1 . So the net asset left is 100-2.1 = 97.9.

Annual Expected return before costs is 14%. That is on 100 assets under management return is 14.  On net asset left i.e. 97.9 return will be = 97.9 *14/100 = 13.71 %

3) As the net return to the client is 13.71% and on the global benchmark, the return is 10%, the client can expect the portfolio to outperform the global index.