How smarter fee budgeting can redefine an advisor’s value

Portfolio construction is the art and science of allocating scarce resources, thoughtfully, to maximize the likelihood of achieving financial goals. Each of the four main budgeting categories – risk, alpha, fees and tax – is finite. Overspending in one area can limit effectiveness elsewhere, and neglecting any one of them can undermine an investor’s entire strategy.

Rising global trends towards fee transparency include, in Canada, total cost reporting enhancements (TCR, also known as CRM3). This could create a value-defining moment for investment professionals.

To PICTON Investments, advisors who apply modern best practices for allocating their portfolio’s fee budget could elevate the value of their advice, potentially delivering better client outcomes, differentiating their practice and attracting new business. What do these modern best practices look like? And how can a fee budget be allocated more efficiently to help advisors achieve their client goals with greater certainty?

Understanding the value of an investment strategy

Investment strategy returns break down into market, style and skill. Dissecting the sources can determine the true value of that investment strategy.

Broad market exposure or beta is cheap and plentiful. It can generally be accessed cost efficiently.

Style or factor exposures are scalable and can be accessed via systematic rules-based approaches. However, they require thoughtful implementation.

Manager skill is rare, valuable and constrained by capacity. In PICTON’s view, it should command a meaningful fee premium over market and style returns.

Put simply, a portfolio’s fee budget is best spent on paying for manager skill. This means focusing a fee budget on allocations that can offer the potential to deliver asymmetric returns (more upside than downside), or uncorrelated returns (not dependent on the direction of the stock or bond market). Generally, these types of return streams can’t be replicated by making allocations into low-cost investments that provide market exposure.

For illustrative purposes only

Capital and fee budget allocations are shifting

Two decades ago, 72 per cent of capital was allocated into traditional long-only actively managed funds. Today, that share has declined to 45 per cent. Instead, more and more of that capital is being redirected to a combination of passive investments and alternative strategies, at 23 per cent and 19 per cent market share, respectively.

Similarly, the percentage of fee budget allocated to traditional long-only funds has decreased to 33 per cent from 62 per cent, and the allocation to alternatives has increased to 53 per cent from 31 per cent.

Source: Boston Consulting Group. Data as of Apr 2025. https://web-assets.bcg.com/cc/0a/25876ea740168e908a8652e147d7/2025-gam-report-april-2025.pdf

This shift isn’t a rejection of active management. Instead, it recognizes that manager skill can be accessed more cost effectively by unbundling market exposure from manager skill.

Today, investors and advisors know how to maximize value relative to cost in their portfolio. They can do so by combining low-cost market exposures with high-value alternative strategies. The result could be the potential to deliver more diversification and greater access to manager skill – and at a lower overall cost.

A useful analogy: the power of unbundling

This evolution mirrors changes in other areas, such as the rise of streaming services. Consumers used to have to subscribe to expensive cable packages that included hundreds of channels, even though they probably only wanted to watch a handful of them. Today, streaming allows you to select only the content you want to watch, whenever you want, at a fraction of the cost.

Similarly in the investment industry, accessing manager skill traditionally meant buying a mutual fund and paying active fees for the entire package, even if only a small portion was worth the premium.

Now, investors can separate market exposure (via low-cost passive funds) from manager skill (via high-value alternatives), while aiming to achieve better outcomes at lower costs. It’s like the streaming model for investing.

Fee budgeting in action

Consider a traditional equity fund with a 1 per cent management fee. In many funds, 90 per cent of the risk and return comes from the market, and only 10 per cent from active management. If market exposure can be obtained for just 5 basis points (via a passive index ETF), then 95 basis points are effectively being paid for manager skill. That translates to a 9.5 per cent fee for the actively managed part of the portfolio.

Compare that to a more thoughtful way to spend a fee budget.

An investor could achieve a similar outcome by having a portfolio investing 90 per cent in a passive ETF that charges 5 basis points and 10 per cent in a hedge fund charging a 1 per cent management fee. The total management fee drops to just 0.15 per cent, resulting in an 85 per cent reduction in fees.

What if the hedge fund has a 20 per cent performance fee? The portfolio would need to achieve a gross return of 43.5 per cent before the total management fees and performance fees paid by the investor equalled the 1 per cent management fee of the traditional fund.

The goal is to spend more on alpha and less on beta. A 70/30 split between low-cost market beta and high-value alternatives could triple the exposure to manager skill, while still cutting management fees by two-thirds to 0.33 per cent. In this scenario, the investor still does not pay higher fees until the portfolio achieves a double-digit gross return.

Learn fee budgeting best practices

PICTON believes fee budgeting is a critical tool for modern advisors. With TCR coming into effect in 2026, there has been a real sense of urgency to build this core competency.

Over the past few months, Robert Wilson, CFA, CAIA, Head of Innovation and Portfolio Strategist at 2ND ENGINE by PICTON, along with the 2ND ENGINE consulting team, have been meeting with advisors to help them review their portfolios and recommend fee budgeting best practices. By treating the fee budget with the same care as capital allocation, advisors can unlock better outcomes, enhance client satisfaction and even win new business.

For an introduction and overview of how fee budgeting works in practice, downloading our free Advisor Guide on “The value opportunity:How fee budgeting can help you differentiate yourself from your peers.”

Advertising feature provided by PICTON Investments. The Globe and Mail’s editorial department was not involved.