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Performance fees still need work: Morningstar

[UPDATED, ADDS FMA COMMENT] Some New Zealand fund managers are still charging inappropriately structured performance fees, despite FMA attempts to offer guidance, Morningstar director of manager research ratings, Asia-Pacific, Chris Douglas said.

Wednesday, July 19th 2017, 12:22PM 4 Comments

by Susan Edmunds

He said there were a number of absolute returns-style managers who structured their performance fees so they were rewarded on a cash-rate-plus basis.

That meant finds could ride equity markets up, and perform barely above the index, and still charge performance fees of up to 5%, he said.

Some managers would have a higher rating on Morningstar’s database if they had fairer fee structures, he said.

The FMA issued a guidance note last year, which described how performance fees should be disclosed, and said when a fund’s hurdle rate of return is linked to the performance of a market index different to the comparative index, this should be clearly disclosed in the PDS so that prospective investors understand the implication.

But Douglas said that had made little difference. “We haven’t seen any behaviour change as a result.”

Fisher Funds charges a performance fee on its growth KiwiSaver fund, which is equal to 10% of any return that is more than the OCR plus 5%. The fee is capped at 2%.

Milford’s active growth fund takes 15% of  performance over 10%.

Fisher Funds chief executive Bruce McLachlan said that could sometimes benefit investors because they would not pay the performance fee, even if the manager had beaten other fund managers and the index, but had not delivered sound real returns. “Even if we are doing well compared to others, if the client is not doing well, there’s no performance fee.”

Performance fees were a way to align client and manager motivations, he said.

The highest performance fee ever charged by the growth fund was 1.41% in the year to June 30, 2013.

Fisher Funds also uses a high-water mark, so that managers cannot be rewarded for the same results twice.

McLachlan said Fisher Funds had been transparent about its fee structure and the FMA had not raised any concerns.

An FMA spokesman said: "The law states that a comparative index must be used, but it also allows the hurdle rate for performance fees to be linked to an index other than the comparative index.

"In our guidance, we have said it is reasonable for the hurdle rate for performance fees to be linked to the comparative index. We have also said that where the hurdle rate is linked to something different, that should be clearly disclosed and explained. That remains our position."

He said where the FMA saw disclosure that did not meet legal requirements, it would engage with the provider to improve it. That would also be the case where disclosure was not consistent with its guidance.

"We expect providers to be able to explain to their investors why the hurdle rates and benchmarks they have chosen are reasonable. And we encourage investors to question their providers about that."

Tags: Fisher Funds FMA funds management KiwiSaver Milford Asset Management Morningstar Performance fees

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Comments from our readers

On 19 July 2017 at 2:50 pm Brent Sheather said:
Good work Morningstar. Let’s think about the statement that “performance fees align client and manager motivation”. The NZ Super Fund is on record as saying it would not invest in any plain vanilla equity fund that had a performance fee. Is the NZ Super Fund silly? I don’t think so.

Bruce McLachlan is wasted at Fisher Funds – he should go into politics.

My view is that performance fees are a huge scam and I am sure the FMA will be embarrassed by that last paragraph. Let’s hope they are embarrassed enough to follow the FCA’s lead and do something about our dysfunctional fund management sector.
On 19 July 2017 at 4:03 pm AFA said:
It's the old story......A rising tide lifts all boats. And retail investors are only concerned with the bottom line i.e. "Is my fund holding growing in value?" Meanwhile fund managers like Aspiring - for example- get away with paying themselves a "Performance fee" for earning a return higher than the cash rate after tax, effectively about 1%. Nice work if you can get it......
On 21 July 2017 at 1:09 pm b p said:
It would be "good work" if morningstar refused to give a rating to a fund that has what they regard as an inappropriate performance fee, but sadly they don't. As long as managers pay morningstar for ratings I cant see morningstar taking what is an obvious moral stand.

Yes I know morningstar are going to come out now and say "managers dont pay for ratings", but given that a manager has to sign up for "research services" from morningstar before getting a rating for any of their funds, it is pretty easy to play the "cui bono" game........

And as for Bruce McLachlans comment "Performance fees were a way to align client and manager motivations", I think any investor would love to hear how the incentives are aligned when the fund has negative performance. If Bruce was really being honest, then surely Fisher Funds would be paying a non-performance fee to the fund if they underperform OCR+5? We would soon see fund managers move either away from performance fees altogether or at least to a legitimate benchmark (i.e., not OCR for an equity fund (!)) if the performance fee was a true alignment of interest and went both ways...... but sadly the prospect of some of these fund managers truly aligning interests with investors is remote. Care to comment Bruce?

The FMA clearly wants to put the onus on investors to change the behaviour of large managers by forcing better disclosure on the industry, yet that process has been continuous push back by large integrated fund managers who have been very successful at diluting the FMA's good intentions. Assymetry of information and knowledge means most investors will never have the ability to question the slick marketing and behavioural approach of many product providers.
On 25 July 2017 at 1:01 pm cdouglas said:
Hi b p,

Thanks for your comments. It's always great to read the articles and comments on Good Returns. I lead Morningstar’s research coverage in New Zealand and would like to respond to both of your comments relating to Morningstar, so we can clear some things up.

We are staunchly independent, and very proud of this.

Morningstar does not charge fund managers to rate their funds and fund managers don't sign up for "research services" before they get a rating. We offer a user-pays research model. Our revenue for fund research in New Zealand mostly comes from financial advisers, who pay to access our insights. Once a rating has been published fund managers can chose to pay to licence the research report (user pays) but there is no obligation, it’s kept separate from our research team and has no bearing on the rating. Overall it is a very small part of our local business. Overwhelmingly, our revenue in New Zealand comes from three sources: AFA’s buying our Adviser Research Centre (ARC) software, larger clients buying our global data and research platform Morningstar Direct, and finally our large data and investment reporting/analytics business.

This allows us to be truly independent. I believe our research and ratings very much reflect this, and I would love to hear your views on where you think this is not the case.

Which leads me onto performance fees. We don’t cover all funds in New Zealand, and pass on plenty that we do feel have inappropriate fee structures (much worse than the two fund managers highlighted in this article). But cost is just one input into a fund rating, and we can also use our voice to push the cost down for investors. We do this and we have seen examples where fund managers have listened and investors have ended up with a better deal. I think that’s pretty cool.

Chris Douglas
Morningstar

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