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Performance fee structures shortchanging investors

Most managers charging performance fees are not doing so in a way that best serves investors, it has been claimed.

Monday, September 28th 2015, 6:00AM 5 Comments

by Susan Edmunds

Morningstar director of manager research ratings Tom Whitelaw said there were a number of things many performance fee-charging funds were not doing well.

First was equity managers not benchmarking against an equity index, instead using a measure such as the official cash rate plus 5%. “Why should an equity manager receive a fee just because equity markets go up? If the market is up 20% and they are up 10% they take a fee even though they are behind.”

The second was that the high water marks – the standard set by previous performance, which managers have to beat to earn their fees – should not be able to be reset.

He said if they were, that could mean an investor could start with $100,000, lose $20,000, have a manager reset the high water mark to $80,000 and then have to pay performance fees when the investment returned to its original $100,000.

Whitelaw said most equity managers in the market were not meeting these standards.

But Mark Houghton, of King Tide Asset Management, said performance-based fees were the only structure that aligned the interests of the fund manager with those of the investor.

Houghton said: “Our fees are some of the highest of anyone … but we have beaten the market by 12% over the past 12 months, after all fees.”

He said much of the industry’s dialogue about fees was self-serving. “If you take a fund management business that simply charges an admin fee, the only way for it to grow is to get more FUM. More FUM is not in the interests of the investor because the bigger you get, the harder it is to get outsize returns, beat the market and protect capital. With a performance fee, you don’t have to get big, you just have to get results.”

One of the most high-profile funds charging performance fees is Milford. It benchmarks its global fund against the OCR plus 5% and its transtasman fund against a 50/50 mix of New Zealand and Australian sharemarkets. Its absolute return funds reset their high water marks after every six months of positive performance.

Managing director Anthony Quirk said: “There is so much debate on performance fees, it’s a complex area. You have to think carefully about the way they are structured.”

He said clients liked the idea that Milford did not “clip the ticket” no matter how it performed.  “But it’s important to have choice.”

Clients should look at the return after all fees, he said. "We charge a low capped fee and take on board the fund costs. We paid $5.3 million to suppliers last year and in return share in the upside with clients. Clients get 85% to 90% of the upside and we get 10% to 15%."

John Berry, of Pathfinder said his firm took the approach that fund managers should invest in a fund to align their interests, not charge a performance fee. Performance fees provided no alignment of interests when markets were dropping, he said.

Whitelaw said:  “An absolute cash benchmark style with low hurdles is great in a falling market but we expect equities to go up over time and that means it’s money for nothing.”
 

Tags: fees John Berry King Tide Milford Asset Management Pathfinder Asset Management

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Comments from our readers

On 29 September 2015 at 10:29 am Mark Houghton said:
Alignment of interest is equally applicable in up and down markets. Performance in down markets is in fact more important than performance in up markets. A manager who is rewarded by performance fees will be very focused in down markets to limit losses, so is strongly aligned him with investors.
On 30 September 2015 at 6:52 am Pragmatic said:
I agree with Mark Houghton: Performance fees are charged by Managers who perform.

Those who have an inability to outperform are often the champions of nil performance fees... These capabilities are considered passive, and should be assessed on price. If you're paying more than 30bps for these, then you're paying too much.
On 1 October 2015 at 8:57 am Brent Sheather said:
Pragmatic,

If you are an AFA your comments are a huge indictment of the licencing system, the Code of Conduct and the farce that is CPD in this country.
On 1 October 2015 at 11:46 am Pragmatic said:
Brent - often when something is said that you don't agree with, it's useful to explain why rather than attacking the individual & the system. In my defense: it is very easy to mistake price & value, with many proponents of (quasi) passive investment learning the hard way

To be clear: if you follow passive beliefs, then price is a good yard stick, with anything over 30bps too much. Otherwise you get what you pay for
On 1 October 2015 at 1:00 pm winstonkey said:
sounds like a BDM......

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