Investors talk a good story when it comes to fees. While much of the conversation is begun by those who advocate index funds or exchange traded funds (ETFs are index funds that trade like stocks), the question of fees, how they should be paid and even more importantly, how much is usually based on why they (actively managed mutual funds) charge the rate they do. If mutual fund fees are so important to the investor, why haven’t they pushed harder for performance based fees?
Often referred to as the fulcrum fee, this method of charging the investor based on how well the fund manager actually did has been attempted in the past (and is currently being adopted by the Janus fund family) but has not received much more than a luke warm embrace. Is it because we simply don’t invest the way the wealthy do?
According to an article published by Advisors Perspective recently, the adoption of this sort of payment for performance is something wealthy investors want, mimicking what hedge fund investors have been paying. Here’s the way it works. A fund earns a hypothetical 50 basis points in fees. If the fund fails to beat or barely beats the benchmark by 20 basis points, what the paper calls the null zone, the fund earns its 50 basis points. If the fund whips the benchmark by 200 basis points, the fund manager(s) earn an additional 50 basis points in fees. Miss the mark by 200 basis points and fund managers earn nothing.
This is referred to as symmetrical because the fee structure punishes as equally as it rewards. To look at buying a fund, often done when performance has been better than average would give the investor the impression that high fees were the norm. And although Fidelity, USAA and Janus all offer a version of this type of fulcrum fee, only the Dunham funds offer the fee structure exclusively and based on a 12 month average. The other fund families offer a three-year trailing charge for fees.
What this means is that should a fund do well in the previous year, beating the benchmark handily, part of the reason it may have done so was because the fees were based on a previous performance model. If the performance was not beat, then the fees against that performance would have been lower, giving the impression of having done better than they may have actually done.
Dunham believes that wealthy investors (ones the are pre-qualified) are going to embrace this type of investment with fees charge on performance – Dunham does this exclusively – in part because they do not want to pay for services that do not provide adequate returns.
According to Chuck Jaffe, it may only be the wealthy who understand this. Earlier this year, he reported the death of a similar fee structure that was ended when TFS Capital killed “off the most aggressive performance-based fee structure in the fund business”. TFS wanted to charge the investor nothing if the fund didn’t do what it promised to do.
Larry Eiben, TFS’s chief operating officer found the problem not with investors, but with the SEC. Their rules, he said, “would not allow it”. Almost sounding regretful, he bemoaned the change back saying “You’d like to have a simple structure, where you only pay the fund if it deserves it, but that’s not really possible right now.”
Without the fulcrum fee model, even if your mutual fund doesn’t do well, your fund manager will still get paid. And even if the fund may have taken on out-sized risk to achieve out-sized gains, the idea should be revisited at some point in the future. Perhaps before we experience another severe downturn, an event that always prompts either investor revolt or a flight to low-fee, conservative investments.
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Mutual Funds Fees: Performance on the Fulcrum
May we have your permission to post this article to Dunham’s website?
Thank you,
Keely Minton
Marketing Communcations Manager
Dunham & Associates
Yes, Keely, you may repost it. Be sure to give the proper bylines and thanks for asking first!
Best,
Paul