One of the world's largest fund managers has broken away from the controversial fixed fee model. Stephanie Baxter looks at why symmetric performance fees are better for pension funds.
The most prevalent fee structure in investment management, a charge fixed as a proportion of assets under management (AuM), has come under scrutiny in recent years.
Critics argue the ‘ad valorem' model is best suited to fund managers and rarely suitable for their clients, as it incentivises the fund to amass more assets.
Following its ground-breaking research in 2014, Cass Business School - part of City University London - published a report which stated the fixed fee model is the least appropriate from the perspective of investor welfare, creating an incentive mismatch. In Heads We Win, Tails You Lose. Why Don't More Fund Managers Offer Symmetric Performance Fees? academics called for a fee structure that better aligns investors' and managers' interests by sharing losses as well as gains, known as symmetric fees.
A leap forward
Almost three years later, Fidelity International is overhauling its charging model by introducing a so-called ‘fulcrum fee', conceding that fees should be symmetrically linked to performance.
The new structure across its active equity funds for both retail and institutional clients will employ a baseline fee that is reduced or increased depending on whether the fund produces underperformance or outperformance.
Given Fidelity is one of the world's largest fund-houses with $258bn AuM (£200bn) in its international business alone, surely its competitors will sit up and listen.
President Brian Conroy says: "We are passionate about giving our clients both choice and value and these changes will even better align our services directly to their needs and expectations."
The fund giant says it will work with all its clients over the coming months to discuss and implement the changes.
Reaction has been broadly positive so far, with Cass Business School professor of asset management Andrew Clare calling it a "great leap forward" and saying he "hopes it will lead to more investor choice in the future".
"Our 2014 analysis said there should be some demand for this from investors, and they aren't getting a choice at all," he adds. "At a minimum you'd expect large companies with fairly stable cash flows to be able to take the chance to offer something different. If Tesco only sold sliced white bread, you'd go somewhere else. It's a great move for investor choice and we hope other asset managers follow suit.
"Not every investor will want a symmetric base fee and not every manager will want to offer it, but large fund managers running lots of funds should be able to offer it as a choice to their investors."
"Everywhere else in life if you received substandard performance, you either don't go back or expect some money back," he added. "The industry needed one organisation to take a brave step forward, and Fidelity has done that."
Lack of detail
Punter Southall head of manager research Katherine Lynas, whose firm advises medium-sized pension schemes, says the framework aligns the investors' interests better than existing flat charges.
However, she does not think it will be widely adopted by other managers, because it is so difficult to communicate. "This is what Fidelity has gotten wrong this time round as it hasn't yet given advisers and investors a lot of detail to be able to assess the model properly to say whether it's a good idea or not."
Just like fixed fees, performance fees and fulcrum fees can be good or bad value for money; it depends on the level they are pitched at, and the specific fund in question.
"We also have to be very careful about using this model for all managers, because if the manager is underperforming, that pressure to outperform may make them increase level risk in the portfolio," says Lynas.
"As long as the structure around it is robust, and as long as you strip away the fact the communication has not been ideal, then I think what they're trying to do is really positive."
Orbis Investments head of UK Dan Brocklebank, whose firm adopted fulcrum fees in 1990, says although they can suit investor preferences, one drawback is where they are calculated back over the past three years.
"The three-year look-back period does mean that this is not perfectly aligned for all investors but, assuming investors come in with a long enough horizon, this should not be an issue over the full investment cycle.
"The other advantage is that this is likely to be more stable and predictable than fee structures that are calculated over shorter time periods. So you get some linkage to performance (which is good) but it's not perfectly direct but you get some stability and predictability to offset that weakness," he adds.
A perfect fee model?
Despite the lack of detail over Fidelity's new model, it has certainly put new life into the debate over charging structures at a time when the value for money debate is rife.
"Even if it's not a perfect symmetrical structure, it's different and has some symmetry in it," says Clare.
There is probably no such thing as a ‘perfect' fee structure, and it is hard to get the right balance.
Orbis's own structure has evolved in response to its clients' needs. In 2004 it lowered its base fee and introduced a share ratio with a refund mechanism where fees are put into a reserve fund and refunded if managers outperform and then underperform. This is to prevent managers loading up on risk, having one great year, charging a performance fee, and then in years two and three they may end up underperforming. Then, three years ago the manager reduced the base fee to zero, so it is only paid performance fees now.
In reaction to Fidelity's announcement there has been concern that symmetric fees are complicated to understand and compare with other fees.
More complexity should not be a barrier to changing an industry norm, Lynas says. "Any difference brings to lights failings in one method versus another method, so it helps to compare and contrast. It may create a bit more work for us, but the outcome will be better for the investor."
One wonders why it has taken so long for a major asset manager to break the mould?
Clare says: "The investment consultants help pension funds put downward pressure on the fee model to get lowest fixed fee, but what they haven't had is the imagination to move away from fixed AuM fee and make it symmetric."
For Lynas, it is a case of medium-sized pension schemes not having the governance time to get into this kind of nitty gritty detail.
"We talk to managers about different fee models and pricing structures, but without the weight of our clients' wish behind us, it's difficult to get those implemented."
There are many unanswered questions around Fidelity's model but it should be praised for moving to better align its interests with its clients. While its competitors are unlikely rush to offer symmetric fees anytime soon, it has reignited the debate and gives pension funds fresh ammunition when negotiating fees with fund managers.
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