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ANALYSIS: Investors want good performance but do they want performance fees?

Friday 29th March 2019

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The extent of the performance fees Vital Healthcare Property Trust’s manager collects highlights the lack of hurdles that correlate with investor returns in the calculation of such fees.

Too often, such fees don’t actually relate to how well the manager has actually performed.

In Vital’s case, its manager, Canada-based NorthWest, is entitled to 10 percent of the rise in value of Vital’s gross assets over that year and the previous two years. That means that when property values are rising generally, NorthWest doesn’t have to do anything much or nothing at all to collect.

And anything NorthWest borrows or buys on Vital’s behalf adds to Vital’s assets and boosts NorthWest’s performance fees.

Of its $22.1 million in total fees and expenses charged to Vital in the six months ended December, NorthWest claimed $5.1 million as its “incentive” fee.

Mint Asset Management highlighted the other end of the spectrum, where performance fees do require significant out-performance before they’re paid. It is abolishing performance fees on its retail funds.

Founder and managing director Rebecca Thomas says although returns on the Mint Trans-Tasman Equities fund have exceeded the benchmark S&P/NZX 50 Index every year since inception in 2007, her firm has only collected a performance fee once in all that time, in the year ended March 2013.

The Mint fund’s performance has to exceed the NZX50 plus 3 percent before it can collect any performance fee and it has a high water mark feature, meaning it can only collect once for the same performance.

In the 2013 financial year, the fund’s performance was 27.45 percent compared with the index’s 26.02 percent gain.

In the year ended March 2018, the fund’s performance of 19.41 percent compared with the index’s 15.59 percent wasn’t sufficient to allow the collection of a performance fee.

So you could say Mint is making a virtue of necessity, given the unlikelihood of it ever collecting performance fees.

Other fund managers, including Harbour Asset Management, Milford Asset Management and Fisher Funds Management, including the latter's listed Kingfish fund, take the high water mark approach to calculating performance fees.

Like Mint, Harbour isn’t collecting a lot of performance fees at the moment. Three of its various funds can earn performance fees but have to outdo their respective benchmarks plus 1 percent or 2 percent, depending on the fund, before a performance fee kicks in.

It currently doesn’t expect any performance fees to be payable this calendar year.

Managing director Andrew Bascand says the whole point of hurdles for performance fees is that they should be difficult to reach. His firm has no current intention of getting rid of them.

Thomas, who is a former Financial Markets Authority board member, says she thinks people don’t understand how high a hurdle Mint has to clear and that it’s constantly ratcheting upwards. It’s easier just to get rid of it.

“I’ve given up trying to describe how it works so I thought, stuff it, let’s just clean it all out – stuff it being a technical term, of course.”

But Thomas says this has nothing to do with her views of where markets are heading. “We’re probably more positive about the next 12 months than we were about the last 12 months,” she says. The NZX50 is at a record and is up almost 11 percent so far this year. 

Mint isn’t making any other changes to its fees, unlike PIE Funds which abolished performance fees in June last year but ratcheted up its base fees to compensate.

For example, the base management fee on PIE’s specialist funds went from 1.5 percent of net assets to 1.85 percent while the fees on its “climate-friendly” fund rose from 1.25 percent to 1.45 percent.

Thomas is critical of funds that use benchmarks which are unrelated to the asset class the fund is investing in.

For example, Fisher’s listed Kingfish fund’s performance hurdle is the New Zealand 90-day bank bill index plus 7 percent but Kingfish’s purpose is investing in New Zealand shares.

Fisher’s listed Barramundi fund, which invests in Australian shares, and the Marlin fund, which invests in global shares, share the same NZ 90-day bank bill benchmark, plus 7 percent in Barramundi’s case and plus 5 percent in Marlin’s case.

And Fisher’s unlisted growth funds have a benchmark of the Reserve Bank’s official cash rate plus 5 percent.

The product disclosure statement for the unlisted funds makes it clear that “this means you may pay a performance-based fee, even if the funds’ performance does not match or beat the market index.”

But one benefit of this is that “you will never pay a performance-based fee if your investment performance is negative.”

The New Zealand equities market looks set to enjoy its 10th successive positive annual return in the 12 months ending this month but in the year ended March 2009, for example, it fell 25.36 percent after a 15.5 percent decline the previous year.

Fisher chief executive Bruce McLachlan, says that “where a Fisher Funds fund does have a performance fee, this is clearly communicated and reported on and Fisher Funds benchmarks the fees on best practice guidelines issued by the FMA.”

Because the company operates in a competitive marketplace, “all features of every fund are always under review to ensure they are relevant and competitive,” McLachlan says.

“Our primary gauge for this is feedback from our 270,000 clients.”

Milford has a range of funds that are benchmarked to the relevant benchmark of the assets they invest in, called “relative return funds,” but it also offers a range of “absolute return funds.”

For example, its Australian Absolute Growth fund has a benchmark of New Zealand’s official cash rate plus 5 percent.

Chief investment officer at Milford, Brian Gaynor, says when the firm started in 2003 it looked at using a share index for a fund investing in shares in that index.

“We decided that wasn’t really what clients were after.”

They were looking for a core positive return and didn’t want to see a fund manager rewarded for a negative return, even if that negative return was less negative than the benchmark.

“Retail investors in New Zealand tended to throw their hands up” at such performance fees, Gaynor says.

Milford’s absolute return funds also have the ability to reduce exposure to equities if the manager thinks equities are going to fall.

Through the GFC, when equity benchmarks were strongly negative, Milford’s Active Growth fund “never had a negative return,” because of this flexibility, Gaynor says.

“They’re dramatically different types of funds,” and Milford has no plans for change, he says. “We’re finding clients are very happy with the things that we do.”

Another of Milford’s points of difference from other funds is that it doesn’t charge separate administration fees.

As for the FMA, it says it welcomes “any proactive movement from MIS – managed investment schemes – managers where they more closely align their fees with the interests of their investors” and that performance fees aren’t prohibited by the Financial Markets Conduct Act.

The regulator has provided various pieces of guidance to help managers understand their obligations to disclose details of their fees but it isn’t the FMA’s job to set fees. The rules for KiwiSaver fees are a little different and none of the funds discussed in this story are KiwiSaver funds.

“The rules are clear on how performance fees and other fees should be disclosed," the authority says. "We have focused on improving transparency and consistency of fees so that investors can better understand what they are paying for and have well-informed conversations with their providers about whether they are getting value for money.”


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