Janine Starks is a financial commentator specializing in banking, personal finance and fund management.
OPINION: Stock markets have become a headache. With prices falling, the party is over for fund managers who charge a performance fee.
Kiwi’s most notorious case should be the 24% annual fee charged by NZ Funds last year, in its core growth portfolio on the back of a large bitcoin position in its fund. The expenses were 24% of the total fund value during the year. Of this amount, 17% corresponded to a performance fee.
This is the highest performance fee I can remember seeing, in percentage terms.
God knows what the new head of our financial regulator, Samantha Barrass, has made of all this – fresh from the UK and welcome to the wild islands, my dear.
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Those on KiwiSaver or managed funds like Milford, Quay Street, Fisher Funds, NZ Funds and InvestNow won’t pay this type of fee for a while. There needs to be a recovery above the market’s last high for the odious double-dipping to resume, but most look like altar boys compared to New Zealand funds.
Houses cost much less, but in previous decades mortgage interest rates were much higher. Mortgage rates are on the rise, however, as the Reserve Bank Te Pūtea Matua raised the official exchange rate to fight inflation.
Can the regulator stop performance fees?
I would much rather the party be over because of regulatory pressure than a crash in the markets.
The UK regulator is having some success in this regard, with large firms quietly backing away before the VfM report due date. This is an annual report signed by the administrators which justifies the costs/fees and their adequacy with the investment strategy and returns.
Others fail to file reports or write them poorly, proving that directors have no idea how serious this governance requirement is.
In New Zealand, lawyers in our firms are taking over the disclosure regime. I believe there has been an attitude of disclosure offering protection. When disclosing performance fees, you won’t see any of them giving a long-term analysis of their outperformance on a risk-adjusted basis.
Statistically, it is false that performance and fees are highly correlated. Our own regulator can prove it, so why doesn’t it stop them?
It’s not illegal
Because this type of billing grew organically out of marketing, loopholes, and self-regulation. It was not planned and slowly slipped away. When I started my career, the only time I saw a performance fee was on an absolute return fund (these “short” an asset and bet on its fall as well as buying and traditional conservation), or a private equity fund.
Performance fees on long-only equity and bond funds have always sounded like a flashing red alarm bell. They have no justification. Yet a new generation of advisors and clients are accepting a new status quo.
It is difficult to get out of this without legal change. All the regulator can do is put up more hurdles for the directors of these companies to formally justify their existence.
KiwiSaver managers have a legal obligation to provide good value for money, but the regulator relies on a cobbled-together set of rules to force all funds to adhere. Managers are much more belligerent about funds outside of KiwiSaver.
The Autorité des marchés financiers is easily drawn into what I would call the “alternative closing” argument with the managers. That old sales thing where the answer can’t be yes or no. Instead, the choice is an enhanced fee or the old structure. It distracts from ‘no’ as an option.
The regulator forgot that it could push for a bigger legal change and deem performance fees inappropriate for KiwiSaver funds or any retail funds. The alternative close will be attempted until the end of time, because so much is at stake for profitability levels. There is no benefit in giving in, ever.
Investors know these fees exist – it’s their choice
Concurrency with fees does not work well and never works at the retail level. This problem will not be solved when left to market forces. The education and power gap between fund managers and mom and dad investors is too big. The regulator must play a protective role.
The story sold to consumers is that fund managers get better results if we give them more of the returns they get for us. They will try harder if their interests are aligned with ours. Only the net return counts. Price is irrelevant if another fund is cheaper but underperforming.
The truth is that we have been exposed to volatility, level of diversification and range of assets. It’s our risk, not theirs, so it’s our returns. Other funds may have produced less returns, but they probably also had different risk exposures to counter this result.
We already pay these managers a fixed percentage annual fee, regardless of their performance.
By itself, the annual management fee is already a performance-based fee. If an investment house proves that it is consistent and performs well, more investors are attracted. Rising markets and good fund management skills inflate fees on a correlated customer journey – everyone benefits.
Double-dipping with another layer of performance fee is nothing more than a ransom on top of the annual management fee. A ransom based on very little evidence to support the necessity of such charges.
The regulator has his eyes on the target
The squeeze is certainly happening under the leadership of the new head of the Autorité des marchés financiers, Samantha Barrass. She comes from a guarded market with much bigger teeth than we’ve ever seen here and should be pretty out of step with the grunts she’ll be getting.
While the FMA gnash their incisors quite slowly, there seems to be a new “tell-it-how-you-see-it” attitude. In a recent report, they clearly went through the barrel of a complaint from fund managers about not wanting to benchmark against index funds.
“That’s nonsense,” our regulator said. And it was indeed the case.
Who will win?
It’s time for investors to catch their breath and recognize that performance fees are not closely correlated to outperformance. At the same time, the regulator should use this period when fees are not collected to further address the liability of directors to prove value for money. When a recovery appears, companies should feel very nervous about how much they have to justify taking money from customers.
Janine Starks is the author of www.moneytips.nz and can be contacted at [email protected] Opinions are personal and general in nature. They do not constitute a recommendation for anyone to buy or sell a financial product. Readers should always seek specific independent financial advice tailored to their own circumstances.