Legal changes needed to stamp out the fees rort
The sharemarkets have become a party pooper. With the slide in prices, the party is over for fund managers who charge a performance fee.
The most notorious of Kiwi cases would have to be the annual fee of 24% charged by NZ Funds last year, in its Core Growth Portfolio off the back of a sizeable bitcoin position in its fund. The fee was equal to 24% of the entire fund’s value in the year. Of this, 17% was a performance fee.
It is the biggest performance fee I can remember seeing, in percentage terms.
Those in KiwiSaver or managed funds with the likes of Milford, Quay Street, Fisher Funds, NZ Funds and InvestNow won’t be paying this type of fee for some time. There needs to be a recovery above the last market high for the obnoxious double-dipping to resume, but most look like choirboys compared to NZ Funds.
Can the regulator stop performance fees?
I’d much prefer the party to be over because of a regulatory squeeze than the markets tanking.
The UK regulator is having some good success in this regard with major firms backing down quietly before enforced Value for Money reports are due. These are an annual report signed by directors that justifies charges/fees and how these align with the investment strategy and returns.
Others are failing to file reports or writing them badly, proving directors have no idea of the seriousness of this governance requirement.
In New Zealand, our firms lawyer-up and grip the disclosure regime. I believe there has been an attitude of disclosure offering protection. When they do disclose performance fees you won’t see any of them giving a long-term analysis of their outperformance on a risk adjusted basis.
Statistically it’s false that performance and fees are highly correlated. Our own regulator can prove that, so why don’t they stop them?
It’s not illegal
Because this type of charging grew organically from marketing, loopholes and self-regulation. It wasn’t foreseen and slowly crept in.
Performance fees on long-only equity and bond funds have always stuck out like red flashing alarm bells. They’ve got no justification. Yet a new generation of advisers and clients accept a new status quo.
It’s hard to stomp out without legal change. All the regulator can do is put more barriers in place for directors of these firms to justify their existence formally.
KiwiSaver managers have a legal obligation to provide value for money, but the regulator relies on a cobbled together collection of rules. Managers are being far more belligerent about funds outside KiwiSaver.
The Financial Markets Authority gets easily dragged into what I’d term the ‘‘alternative close’’ argument with managers. That old sales trick where the answer can’t be yes or no. Instead, the choice is an improved fee or the old structure.
The regulator has forgotten it could push for larger legal change and deem performance fees inappropriate for KiwiSaver funds or all retail funds. The alternative-close will be attempted until the end of time, because so much is at stake for profitability levels.
Investors know these fees exist – it’s their choice
Competition with fees isn’t functioning correctly and never does at retail level. This issue won’t sort itself out when left to market forces. The education and power gap between fund managers and mum and dad investors is too great. The regulator must play a protection role.
The story being sold to consumers is that fund managers perform better if we give them more of the returns they make for us. They will try harder if their interests are aligned with ours.
The truth is, it’s our risk, not theirs, so these are our returns.
We already pay these managers an annual fixed percentage fee regardless of how well they do. In itself, annual management fees are already a performancebased fee. If an investment house proves it’s consistent and delivers good results, more investors are attracted. Rising markets and good fund management skills inflate fees on a correlated journey with clients – everyone benefits. Double-dipping with another layer of performance fee is nothing more than a ransom on top of the annual management charges.
The regulator is watching
The squeeze is certainly happening under the direction of Samantha Barrass, the new head of the Financial Markets Authority. She comes from a market policed with far bigger teeth than we’ve ever seen here and should be fairly unfazed by the grumbling she’ll experience.
While the FMA is gnashing its incisors fairly slowly, there does appear to be a new ‘‘say-it-how-you-see-it’’ attitude. In a recent report it clearly stared down as ‘‘nonsense’’ a complaint from fund managers about not wanting to compare themselves to index funds.
This issue won’t sort itself out when left to market forces.
Who will win?
It’s timely for investors to recognise performance fees are not closely correlated with outperformance. The regulator should also use this period, where fees aren’t being earned, to go in harder with directors’ liability for proving value for money. When a recovery appears, firms should be feeling very nervous at how hard they have to justify taking clients’ money.
Janine Starks is the author of www.moneytips.nz and can be contacted at moneytips.nz@gmail. com. Opinions are a personal view and general in nature. They are not a recommendation for any individual to buy or sell a financial product. Readers should always seek specific independent financial advice appropriate to their own circumstances.