By Amanda Morrall
If performance is relative, so too are fees. And the new Financial Markets Authority is looking to establish a gauge by which KiwiSaver providers and members can establish what is reasonable when it comes to being charged a premium on the management of their retirement savings.
Following several inquiries into the sticky issue of performance fees, the FMA this week released a guidance note on the practice asking for some much needed feedback on the subject.
Affected providers will undoubtedly be following the story closely. However those most directly effected by this issue -- a group that makes up the 1.7 million plus KiwiSaver membership -- will likely be asleep at the switch. It doesn't help that the document was released exclusively to providers.
A spokesman for the FMA said members of the public are equally entitled and encouraged to offer their feedback. The deadline for submission is Dec.2, 2011.
In its note, the FMA says it will judge the reasonableness of performance fees on a "case by case" basis that broadly takes into account two governing principles:
1) Whether it is reasonable to offer fair reward for the application of investment manager skill and;
2) Whether performance fees adequately reflect the risks taken by the both the investment manager and the investor.
With respect to the former, the FMA noted the following:
- It can be appropriate to recognise special skills, resources and outcomes delivered by the manager in agreed performance fee arrangements.
- Performance rewards should be built on special skill based factors added by the manager over and above those generally available through "investing in the market" (i.e. recognising alpha not beta)
- When considering what "in the market" means, we will consider the usual investment mix and inherent market return and risk characteristics of the standard or base investment position of the fund concerned in normal market conditions.
- Investors should not pay twice for the same return. Therefore the relativity between any on-going fixed fee in relation to the standard or base investment asset mix and the performance fee must take into account of effective allowance already in that base fee for an element of active management (the beta portion). It is our expectation that the higher the fixed fee, the lower the expected level of the performance fee.
With respect to the second principle, it adds:
- Performance fee structures should be aligned with investor's objectives. The fee structure should not reward managers by giving the manager an undue share of the return that might result from active management. This recognises that the return was achieved by putting the investor's capital at risk.
- Fees structures should be based on an appropriate extended time frame. They should avoid situations where large fees are paid for a single year immediately preceding or following periods of low returns.
- Fee structures should share the downside of performance between manager and investor as well as the upside.
- Performance fee structures should not have the potential to encourage inappropriate or undue risk taking by the manager. For example, they should not have increased portfolio gearing or semi permanent higher risk tilts away from the "standard" investment position.
In evaluating the "reasonableness" of performance fees, the FMA says it will expect that providers who cahrge performance fees will have taken into account a "hurdle rate of return.'' This term is in reference to having delivered a minimum rate of return (expressed as a percentage of assets under management) which accounts for fees already deducted. The hurdle is also expected to reflect the long-term objectives and inherent risks of the fund.
Further, that any performance fee be based on an appropriate benchmark for returns before allowing for a value-add.
It also specifies that any "high-water mark" performance fees provide for the recovery of any under performance.
Having an annual cap on performance fees, an appropriate multi-year assessment period, and reset provisions also form part of its guidance considerations.
An added complexity for KiwiSavers members is not knowing whether a performance fee is embedded in the costs of a particular fund. That's because many providers outsource the management of their funds to offshore managers who may charge performance fees which get reflected in the value of the fund, rather than being explicitly identified.
The FMA addresses that issue in page four of its guidance note and specifies that where a performance fee is payable to a third party investment manager, it is incumbent upon the provider to disclose "key elements of the performance arrangement" to the member.
The guidance note does not address the issue of fees charged by default providers, another contentious subject raised by the FMA. That separate issue is slated to be reviewed by a monitoring panel of the Ministry of Economic Development in a review of KiwiSaver fees in 2012.
Annual cap: The total combined fixed and performance annual fee payable
High water mark:The highest unit price of net asset value per share achieved at the end of any performance fee calculation period. No future performance is payable until the high water mark has been exceeded.
Hurdle rate of return: The minimum rate of return that must be earned in the relevant calculation period before a performance fee is payable with the fee payable on the excess return above the "hurdle rete of return.''
Net asset value: Market value of assets less the net present value of liabilities including allowance for all management fees.
TER: Pending the KiwiSaver Fees Disclosure Regulation becoming law, the TER follows the guidelines set out by the Investment Savings and Insurance Association of New Zealand. See full definition here.
*Corrected copy. Removes a reference to Brook Professional KiwiSaver Scheme.