The release last week of a report on performance fees provided an interesting insight into the charging behaviour of local fund managers.
While the study, authored by rising NZ boutique investment firm Harbour Asset Management, is inevitably self-promotional the underlying content is still worth a read for anyone trying to understand the many subtle ways fund managers can tip the fee equation in their favour.
Harbour argues not against the practice itself but for more rigorous standards of consistency and transparency in the way performance fees are levied. The Harbour study highlights five specific attributes of performance fees that investors should pay attention to:
• Quantum - how much is too much?
• Benchmark - is it relevant to the asset class invested in?
• Performance hurdle and cap - has the managed imposed an alpha target to outperform?
• High water mark - does a manager need to recoup previous losses before charging a performance fee?
• Crystallisation period - over what time frame is a performance fee assessed?
These are useful pointers for anyone trawling through fund offer documents trying to figure out how much their manager is, or could be, charging them - and whether it's justified. Importantly, it's not just investors in so-called sophisticated products who need to keep an eye out for these tricks, as some KiwiSaver providers, such as Fisher Funds, are also performance fee junkies.
The Financial Markets Authority (FMA) released guidelines on KiwiSaver performance fees last year, which Harbour says are nice enough but lack regulatory force.
In the study, Harbour rates the performance fee structure of 11 New Zealand funds - naming only its Australasian Equity Fund - against its five standards.
Unsurprisingly, the Harbour fund was the only one ticking all the five boxes - make what you will of that finding. The Harbour report, in fact, pre-empts the publication of a performance fee study of New Zealand managers by research house Morningstar. Due out in a few weeks, the Morningstar report should add some depth to the debate and may, or may not, 'name and shame'.
The Harbour study itself was based on a Morningstar Australia report published last April titled 'Best practice in managed fund performance fees'.
The report includes this fascinating fact from the US, which requires fund managers who charge performance fees to adopt the 'fulcrum' method - that is, if you charge more for over-performance, you have to charge less if you underperform.
Sounds fair enough but the US fulcrum experience has not been wholly satisfactory. Let Morningstar explain:
"The reaction of US fund managers to more investor-friendly fee structures does not provide a strong endorsement of their confidence in their ability to add consistent value. The introduction of these regulations resulted in the number of mutual funds charging performance fees falling dramatically. The knock-on effect was an increase in the number of hedge funds, given that these less regulated vehicles were not subject to the same ruling.
"Mutual fund managers which employ the fulcrum performance fee approach now tend to cap their upside potential, principally because this also caps their potential downside losses."