Performance fees - who needs them?

Fund managers shouldn't charge performance fees for doing their job, says one industry figure who likens it to a plumber charging a performance fee for fixing a toilet.

Tuesday, January 24th 2012, 6:00AM 4 Comments

by Niko Kloeten

In response to a recent Good Returns story about Harbour Asset Management's survey of performance fees, Pathfinder executive director Paul Brownsey said there was a bigger question to be asked: why have performance fees at all?

"How many other businesses require a performance fee in order for the service provider to do the job they are supposed to do?" he said.

"Do you pay your plumber a performance fee when he keeps the toilet flushing? Do you pay your internet provider a performance fee when access is uninterrupted?

"Do you pay the gardener a performance fee when the flower bed looks nicer than usual? Or an example some finance company directors may appreciate, do you pay your lawyer a performance fee when the sentence is 18 months instead of 2 years?"

Asset managers and advisers are in the core business of "attempting to provide the best possible return to their clients," Brownsey said.

"Why does a performance fee mean the asset manager will do a better job of this?"

He said he would have no problem with performance fees if they worked both ways, "i.e., the manager pays the investor if the fund underperforms."

Harbour Asset Management chief operating office Jody Kaye said he understood Brownsey's sentiment.

"That's a fair comment but it comes back to the quantum of fees, both base management fees and performance fees. We charge the lowest base fees in the New Zealand marketplace [1%] but we have more upside if we have good performance.

"Managers who charge a base management fee of 1.5% and also charge performance fees need to take a look at themselves."

Kaye said that although managers have to disclose how they calculate their performance fees, it isn't always easy for investors to work out what the result will be.

Financial advisers also need to pay close attention to fees and how they're calculated, he said.

"Advisers need to factor in the consequences of both fees and make sure they can understand what it's going to be based on.

"If the market does 25% and your fund does 15% but it outperforms cash by 10%, are you happy to pay a performance fee for that?"

Kaye said New Zealand's base management fees were generally higher than in Australia, where there is more emphasis on performance fees. New Zealand would likely move in that direction as the market matured, he said.

He wouldn't name the funds that had been looked at in the survey but said they were the "top 12" brands with large Australasian equity mandates and were "well known".

Niko Kloeten can be contacted at niko@goodreturns.co.nz

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Comments from our readers

On 24 January 2012 at 12:28 pm Seven said:

The rationale for performance fees is not entirely clear. Some managers argue they give an incentive for fund managers to do their best – as Brownsey points out this has the rather unsettling implication that they would not do their best without it.
Other managers argue that performance fees create the perfect alignment of interest for fund managers and investors. This alignment argument just doesn’t seem right. Firstly, performance fees are an alignment of interest when markets are going up, but provide no alignment when markets are going down. Fund managers investing in their own funds provides a better alignment.
As with any incentive payment, performance fees may encourage managers to take on more risk in the hope of triggering a payout. This may at times be exactly the sort of short term incentive at the core of the GFC that encouraged risk seeking behavior in investment banks.
Kaye's response is a fair one - if a manager wants to take a management fee plus a performance fee "kicker" then the overall quantum and proper disclosure to investors become critical.

On 24 January 2012 at 1:05 pm mike said:

It's easy for Paul Brownsey to comment that performance fees have no business in the fund management game when he runs funds tracking an index and therefore don't necessitate a performance fee. It's quite possible that his 1.1% management fees are also inappropriate.

Harbour have the frame of reference here as they actively manage their portfolios and therefore their ability to run a profitable business hinges on such fees. Let's not kid ourselves here, fund managers are in the game to turn a profit, they're not providing a public service.

If you don't like the fees that fund managers charge then don't invest in their funds, try sticking it in cash or better still, use an online brokerage and see what that gets you.

I agree that high water marks and the benchmarks used are an issue, but it's up to the investor to speak with their feet.

On 24 January 2012 at 2:36 pm Roscoe said:

Bankers appear to get bonuses for simply doing their jobs, so why not fund managers? Isn't that the way of the world?

On 25 January 2012 at 1:41 pm Interested Party said:

Fees are often an argument that is raised when you have run out of things to say. I agree with Mike’s viewpoint – that you get what you pay for in life. If you believe that paying an annual management fee of 1.1% is appropriate for an index like return, then go for it. Personally I’d prefer to receive index-like returns for free (as that is what they are ultimately worth), and pay a premium for extraordinary performance. Mike is also correct in stating that the disclosure of performance fees needs to be tidied up – with the investor having meaningful hurdles and high-water marks in exchange for their investment.

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