Un­fair tac­tics used by some as­set man­agers against you, the in­vestor

Weekend Argus (Saturday Edition) - - PERSONALFINANCE - LAURA DU PREEZ

As­set man­agers of­ten ar­gue that per­for­mance fees are fairer to you, the in­vestor, than set as­set man­age­ment fees, be­cause you pay only when your man­ager de­liv­ers re­turns above the in­vest­ment’s bench­mark.

But there are three ma­jor ways in which th­ese fees may be very un­fair on you, Bran­don Zi­ets­man, chief ex­ec­u­tive of­fi­cer of Port­fo­lioMetrix, which pro­vides as­set man­age­ment ser­vices to fi­nan­cial ad­vis­ers, re­lates in ar­ti­cles pub­lished on www.ad­viser.co.za.

His ex­am­ples high­light some of the is­sues National Trea­sury has raised on per­for­mance fees in its re­cent pa­per, “Charges in South African Re­tire­ment Funds”.


Zi­ets­man says the first prob­lem is that the play­ing fields are not level – the man­ager takes with­out lim­it­ing the per­for­mance to which the fee ap­plies when re­turns are good, but gives up only a limited amount when re­turns are be­low the bench­mark or the per­for­mance fee hur­dle.

An ex­am­ple of how th­ese per­for­mance fees work is where a fee of one per­cent of the in­vest­ment is charged if re­turns equal the bench­mark, but the man­ager takes 15 per­cent of any re­turns above the bench­mark with­out any limit on the per­cent­age of as­sets that can be charged as a fee, Zi­ets­man says .

When re­turns are be­low the bench­mark, the fee de­creases, but only to a min­i­mum of 0.5 per­cent of the in­vest­ment, he says.

Zi­ets­man says funds have pe­ri­ods of out­per­for­mance and un­der­per­for­mance, re­gard­less of whether, on aver­age, they ac­tu­ally beat the bench­mark over time. Th­ese de­vi­a­tions may be quite marked, es­pe­cially when a man­ager in­vests in a port­fo­lio that bears lit­tle re­sem­blance to the bench­mark. The dif­fer­ence be­tween the port­fo­lio and the bench­mark is ul­ti­mately what drives out­per­for­mance and is what in­vestors are pre­pared to pay for. But what you don’t want to pay for are ran­dom fluc­ta­tions, Zi­ets­man says.

He says such a fee struc­ture was tested in a sim­u­lated en­vi­ron­ment on a fund that only de­liv­ers the bench­mark re­turns over time and that has a track­ing er­ror of 11 per­cent (the de­gree to which ac­tual re­turns dif­fer from the bench­mark re­turns). The test showed the fund was likely to at­tract a fee closer to 1.5 per­cent than the one per­cent you would ex­pect to pay for re­turns equal to the bench­mark.

Zi­ets­man says the ad­di­tional 0.5 per­cent was sim­ply a re­sult of a fee struc­ture that al­lowed for limited par­tic­i­pa­tion in out­per­for­mance, even when the fund was not out­per­form­ing its bench­mark at all. This shows how the play­ing fields are not al­ways level, he says,

Zi­ets­man says caps or lim­its on the fees that can be charged when per­for­mance is good – which are known as high-wa­ter marks – can be used to help level the play­ing fields.

High-wa­ter marks en­sure you do not pay fees for out­per­for­mance un­less it is new out­per­for­mance above the pre­vi­ous high­est out­per­for­mance.


A sec­ond prob­lem with per­for­mance fees high­lighted by Zi­ets­man is that you end up pay­ing for per­for­mance you did not nec­es­sar­ily en­joy.

He cites the case of a fund that launched more than 14 years ago and has re­turned, on aver­age, eight per­cent a year bet­ter than the bench­mark for its in­vestors.

How­ever, the fund de­liv­ered ex­tra­or­di­nary per­for­mance in its first year. In­vestors who in­vested in the fund a mere one year af­ter its in­cep­tion re­ceived a re­turn of four per­cent a year above the bench­mark, half of that for the full pe­riod. Zeits­man says this shows how tim­ing mat­ters. He says fees are of­ten based on per­for­mance achieved over rolling pe­ri­ods – two years in this case – and if fees are based on a pe­riod that in­cludes a year of good per­for­mance that you, as an in­vestor, missed, you may well pay more than you should for what you ac­tu­ally re­ceived.

The fund re­turned 17.19 per­cent in 2008 but lost 28 per­cent rel­a­tive to its bench­mark in­dex be­tween Fe­bru­ary 2009 and Fe­bru­ary 2012. In­vestors paid an aver­age fee of 2.51 per­cent a year in fees over those three years of neg­a­tive per­for­mance be­cause of the good per­for­mance in 2008.

The fund’s per­for­mance fee is based on a 10 per­cent par­tic­i­pa­tion rate in out- and un­der­per­for­mance, but this is po­ten­tially mis­lead­ing, be­cause it is based on a two-year rolling pe­riod. Each year is ef­fec­tively in­cluded twice, which means the ac­tual par­tic­i­pa­tion rate is closer to 20 per­cent a year.


The third prob­lem with per­for­mance fees that Zi­ets­man and National Trea­sury high­light is that your man­ager may choose a bench­mark or per­for­mance fee hur­dle that is in­ap­pro­pri­ate.

Zi­ets­man says some multi-as­set funds use the aver­age per­for­mance of their peer group as the ba­sis for the per­for­mance hur­dle that must be cleared be­fore the fee ap­plies.

But, he asks, if the man­agers act as a herd and make the wrong in­vest­ment de­ci­sions, and your man­ager also makes the wrong de­ci­sions but is just a bit less “dof” than the rest, does that en­ti­tle it to charge a per­for­mance fee?

An­other big prob­lem with per­for­mance fees is that some man­agers base their per­for­mance hur­dle on in­fla­tion as mea­sured by the con­sumer price in­dex (CPI), Zi­ets­man says.

“In­fla­tion sim­ply isn’t an in­vestable as­set. Again, this means that much of the per­for­mance fluc­tu­a­tion around an in­fla­tion bench­mark over one or two years is sim­ply ran­dom.”

He says he is aware, for ex­am­ple, of some multi-as­set funds that have an ag­gre­gate weight in eq­ui­ties of more than 65 per­cent of the fund, which charge per­for­mance fees for per­for­mance that ex­ceeds CPI plus five per­cent.

How­ever, be­tween June 2004 and June 2012, if you pas­sively held a sim­i­lar as­set al­lo­ca­tion to th­ese funds in the ap­pro­pri­ate un­der­ly­ing in­dices (with­out ac­tive as­set al­lo­ca­tion or stock se­lec­tion), you may have achieved a re­turn of around 17 per­cent a year, while in­fla­tion was about six per­cent a year.

Hence, a pas­sive in­vest­ment that would have re­quired no more ef­fort than bal­anc­ing the as­set class weights back to the bench­mark as­set al­lo­ca­tion would have de­liv­ered a re­turn that was 11 per­cent­age points above in­fla­tion for this pe­riod.

He says some man­agers, but not all, gen­uinely seek to make their fee struc­ture fair, but the com­plex­ity of per­for­mance fee cal­cu­la­tions makes it vir­tu­ally im­pos­si­ble for con­sumers to iden­tify all the prob­lems.

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