Cost ratios as a measure of fund efficiency

Fund managers are assessed, in part, on their ratio of expenses to assets under management. This applies to all classes of fund managers, including pension fund managers, IFAs, private equity fund managers, and venture capital fund managers. In most cases the logic for looking at expense ratios is very strong:

  • the more money that is spent on fund expenses the less gets invested in underlying assets and hence the performance of those investments has to be better to achieve a given level of return
  • fund expenses are largely composed of investors’ salaries and office costs, above a certain level higher salaries and nicer offices don’t translate into better performance

Therefore, the lower the expense levels the better. Moreover, history is littered with examples of fund managers getting rich on the back of high expense ratios and then not delivering good returns to investors (that’s a bad practice that we want no part of).

Forwards Partners, and an increasing number of higher value add VC firms (see here for a partial list) have different models which require a new way of looking at things. The difference is that fund expenses are increasingly spent on people who work with the portfolio companies to make them more valuable, invalidating the second reason for looking at expense ratios in the above list of bullets – fund expenses are not ‘largely composed of investors’ salaries and office costs’. In our case eight out of our team of thirteen spend all or most of their time working with our portfolio companies.

In fact, our strategy is to have higher expenses in order to attract the best entrepreneurs and help their companies achieve better results. We invest more in support to drive higher returns. That’s on the first page of our pitch deck.

Rather than look at our expenses as a percentage of assets under management, which is high compared with our peers, the right question to ask is whether our investment in supporting our portfolio is working. Does it enable us to do better deals?, and are the investments we make more successful as a result of the help we offer?

The definitive answer to these questions will come over time as our portfolio matures, our companies exit, and we can demonstrate a high cash to cash IRR. Until then investors wishing to assess our model can look at the companies we have invested in to date, the success they are having, and hear about the help we are providing on a day to day basis.