A letter sent out to about 500 fund managers has suggested that they change their fee models to better align interests between investors and fund managers, as unskilled managers currently benefit disproportionately in market growth.
Frontier Investment Consulting managing director Fiona Trafford-Walker suggested that managers change their fee models so they are paid a “flat-dollar fee, with an annual inflation ratchet”, that goes towards covering the fund manager’s business costs. Thereafter, should the fund perform well, they would receive a performance-based fee.
Trafford-Walker said the most common fee structure is that fund managers are paid based on assets under management. She said the problem with this fee structure is that there is often little correlation with the returns to the client.
“Under this structure, fund managers benefit disproportionately as the market goes up but also see revenues fall substantially as the market does,” she stated in the letter.
Trafford-Walker added that she does not accept the argument that the costs to fund managers in managing larger portfolios rise as strongly as costs paid by the client.
She said a negative for fund managers in using this model is that when markets fall, staff are often laid off to recover costs, leaving remaining managers fearful of losing their jobs rather than focusing on managing portfolios, while also having to cope with reduced resources. Ultimately, it is the client who is disadvantaged.
“The reality of a rising market is that many managers generate large fees from general market growth rather than actually delivering outperformance for clients,” Trafford-Walker said. “Poorly performing managers can go on for some years with no excess returns but still make lots of money for themselves and none for the client above an index return.”
She said poor markets expose these people, yet a change in the model to a flat fee to cover costs and a performance fee to actually reward performance would be an attractive proposition to skilled managers, who could actually earn more under such a fee structure.
