In part one of our investigation into fund manager fees, a Cass Business School report suggests your fee structure could be costing you money
Recent research by Cass Business School calls for reform of active managers’ fee structure to align the interests of investors and fund managers.
The most widespread fee structure is for managers to charge a proportion of assets under management rather than a performance related fee. Professor Andrew Clare from Cass Business School says: “Yet this structure is the one that is least aligned to the interests of the investor as it has no link to performance.”
Even if trustees and scheme managers insist on performance related fees, they must think carefully about the structure to ensure that interests are correctly aligned.
A performance related fee can be structured in one of two ways – asymmetric or symmetric. Asymmetric fees have a base fee that is fixed as a proportion of assets under management as well as a performance fee where the managers earns a set portion of the upside performance.
A symmetric fee, however, comprises of a performance fee whereby that manager shares some proportion of both the up and downside of fund performance.
Neither of these decisions is necessarily in the best interests of the investor”
The study looked at the different skill levels of managers and then looked at the impact that an asymmetric and symmetric fee structure would have on the investor.
Professor Clare says: “The point of a performance related fee is that it should more closely align the interests of investors and managers, but this does not always happen with an asymmetric fee.”
Effectively this fee structure gives the manager a free option on the performance of the fund. “This can affect the way they approach the management of fund risk,” says Professor Clare.
If, close to year end, the fund has performed well, they could be motivated to lock in profits and take risk off the table. Or, if the fund is underwater after nine months, they could be motivated to make riskier investments.
“Neither of these decisions is necessarily in the best interests of the investor,” says Professor Clare. “There is plenty of theoretical and practical evidence which shows that asymmetric fees are heavily weighted towards benefiting the manager and much less evidence that it benefits the investor.”
In contrast, for most active managers across a wide range of different skill levels, a symmetric fee ensures that the investors’ interests are much more closely aligned with that of the manager.
A symmetric fee structure would ensure that the fund manager pays back the investors a certain proportion of underperformance and pays out a certain proportion of outperformance.
Professor Clare says: “When the fund underperforms, however, it’s probably a good idea to set a limit on any performance rebate, which should probably be set at the cost of running the fund to ensure that the fund manager’s business can ‘keep the lights on’.”