JOHANNESBURG – When asset managers design performance fee structures, it is rarely a 50-50 game, an industry expert says.
Magda Wierzycka, chief executive officer of Sygnia, says when most asset managers set performance fees, they do it in such a way that the probability of achieving the objectives and levying the fee is skewed in their favour.
This can be done by setting the benchmark at a relatively low level – for instance by not having any hurdle above the benchmark, she says.
Even where performance fees are capped, the caps are usually set at levels that would only be triggered once the manager has outperformed the JSE All Share Index (Alsi) by 10% – something that is very unlikely to happen.
Wierzycka says performance fees can double, triple or even quadruple the amount of fees investors are paying.
Currently, products that charge performance fees can’t be used as tax-free savings accounts. These accounts are supposed to be efficient and transparent but because the performance fee can’t be determined upfront, it doesn’t meet National Treasury’s transparency benchmark, she says.
But in a landscape where fee structures are often opaque and difficult to dissect, what should investors keep in mind when evaluating performance fees outside of tax-free savings accounts?
Questions to ask
Wierzycka says investors need to ask how frequently the performance is calculated.
In many investment products performance is calculated on a rolling basis. This could mean that an investor will be paying a performance fee for performance he never enjoyed, she says.
Investors also need to find out what the asset manager’s level of participation is and whether the percentage is reasonable.
Ask whether the performance fee is calculated before or after the basic management fee has been deducted. In other words, ask if the outperformance is measured net of the basic management fee or gross thereof. There is a material difference, Wierzycka says.
Investors should also ask what the hurdle rate is. In other words, is the outperformance measured against a benchmark like the Alsi or against a percentage point (or more) above the Alsi.
Wierzycka says if there is no hurdle rate, investors should consider the manager’s past performance. If the benchmark is the Alsi, how likely is the manager to outperform this benchmark? How often has the manager managed to beat the benchmark in the past and if they did, how significant was the outperformance?
This will give investors a sense of what the performance fees could entail, she says.
With unit trusts, it is as simple as analysing the history of the manager’s total expense ratio (TER) over time. If the manager’s historical TER isn’t accessible through the website, ask the client service division for a spreadsheet.
“You are within your rights to ask. If someone doesn’t want to answer, is that really someone you want to do business with?”
It is also worthwhile to consider what the TER actually translates to in absolute (rand) terms. Fees expressed as a percentage are much less impactful, she says.
Wierzycka says investors should consider whether there is a cap on the performance fees and if this is really a meaningful number.
If a cap is applicable, ask whether it is applicable to the performance fee in isolation or whether it is applicable to the basic management fee and the performance fee collectively.
Also consider whether a high watermark principle is used. This means that the manager can never levy a performance fee on the same capital growth, Wierzycka says.
For example: If a manager delivers a return of 1% during the first year of an investment (R1 000 of capital growth for the investor), and charges a performance fee, any negative returns that follow (as well as the capital growth of R1 000) will have to be recovered before a performance fee can be levied again.
Wierzycka says investors should also consider the benchmark itself.
At the moment “the easiest benchmark in town” is CPI (the consumer price index), she says.
Inflation is expected to fall on the back of the lower oil price and as a result this target is quite easy to meet, she says.
Investors should also ask whether there is an alternative product available with a flat fee structure.
Wierzycka says typically a flat fee structure has a higher base management fee and no performance fee. The performance fee structure has a lower base management fee but a performance fee element attached to it.
In this instance the difference in the base management fee should be considered. In some cases the difference has shrunk considerably and it may be worth the investor’s while to pay a little bit more as a base management fee but to have the certainty and transparency of a flat fee structure.
Wierzycka says even where investors have limited knowledge of performance fee structures, it is important to compare the structures of different asset managers.
It is naive to argue that performance fees don’t matter because it is only triggered by outperformance. If 10% or 20% of the outperformance is forfeited in good times as a result of the manager’s performance fee, it could have a considerable impact over time, she says.