Fund manager performance fees under fire
Performance fees charged by New Zealand fund managers are often too high and use inappropriate benchmarks, according to a new report by Harbour Asset Management.
Thursday, January 19th 2012, 6:00AM 
6 Comments
by Niko Kloeten
The subject has been in the spotlight recently, with the Financial Markets Authority issuing guidance on what it considers "reasonable" in terms of performance fees for KiwiSaver funds.
Harbour's report examined ten equity funds offered in the New Zealand market and found a number of concerns with the way performance fees were structured.
"Performance fees have the potential to be the highest fee paid by retail investors yet they may not even know they are paying them or how much they are paying," the report said.
"Performance fees can reward fund managers for a job well done. The theory is that when the investor benefits from strong investment performance, the fund manager can also share in their success - a seemingly win-win situation.
"However, the NZ managed fund market experience is that not all performance fees are structured fairly or are transparent. Retail investors may be paying too much in performance fees, or even worse, paying a performance fee when comparable market performance has not even been achieved."
Harbour's analysis used five criteria from a recent Morningstar research paper on performance fees in Australia. These were: quantum; benchmark; performance hurdle and cap; high water mark; and crystallisation period.
The biggest problems were in performance hurdles, where nine out of ten funds weren't judged to be up to scratch (Harbour's Australasian Equity Fund passed on all five criteria) and benchmarks, in which eight of the ten funds weren't seen to have an appropriate equity benchmark.
Only half of the funds were deemed to have a reasonable mix of base management fee and performance fee (quantum).
"It appears few New Zealand managers are operating at a global best practice level when structuring performance fees," the report said.
"Most managers reviewed offered performance fees benchmarked against cash or an absolute level of return when investors are exposing themselves to equity risk. Investors have the potential to pay a performance fee for below market performance."
Niko Kloeten can be contacted at niko@goodreturns.co.nz
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Comments from our readers
And as for Harbour describing the payment of a performance fee as a "win/win situation" - er since when did loading another fee become a "win" for investors?!
Here is another way to describe a performance fee: "If you pay me a performance fee I will actually try harder to the job I am supposed to do anyway."
Much more meaningful than a performance fee is for the managers to invest their own money in meaningful amounts alongside investors - something boutique managers are more inclined to do.
You can't quantify the performance of a plumber or a gardener, it's totally subjective. However, take a sportsman like a tennis player or a golfer, they get compensated according to how they place and their performance. Why reward someone for just showing up? Why not reward excellence? Performance fees reward high performers and encourage performance rather than stifling it.
Management fees, however, just stifle performance - look at most of the managers around town like Devon, Fisher etc, great at raising assets and living off the management fees without any real performance.
Performance fees are usually justified by "alignment of interest." The most effective alignment of interest is for managers to put significant amounts of their own money into funds pari passu with investors. I can assure you that creates significant alignment of interest plus deep interest in good performance.
Harbour are right in pointing out that in NZ performance fees are generally very poorly structured with low hurdles, inappropriate benchmarks, resetting high tide marks etc - the answer is twofold - better disclosure by managers and more questions from investors.
I would have no problem with performance fees if they worked both ways - i.e.,the manager pays the investor if the fund underperforms.
And I think your point about "living off management fees" is sometimes valid, but again this is more that investors in NZ do not focus at all on the TER or MER, many investors seem to look at just the headline management fee and ignore all the other costs and charges that some managers charge back to the funds.
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Note that the performance fees typically only apply in the managers' retail funds, as the managers are smart enough to know that the wholesale market wouldn't tolerate these fee structures, plus asking for these would eat into the manager's credibility.
Come on NZ equity managers, time to lift your game a bit, as this really is an area that you seem to be happy to take advantage of the lack of investor education around this type of issue.
Big ups again to Harbour for getting on the front foot.