All I want for Christmas is no upfront fees

Top of this year’s Christmas shopping list for unit trust investors should be no upfront or initial fees from their investment house. Performance based fees are a viable and fair alternative which align the needs of both investor and asset manager, says Paul Cluer, MD of Foord Unit Trusts.

“The current macro economic climate means that investors will be tightening their belts over the coming months, as well as looking for ways to preserve any profits their investments have generated in the roaring bull market of the past few years.”

Cluer says investors should be looking to put their money with investment houses whose fee structures don’t chew up the money available for investment. “Your asset manager should be trying to keep costs as low as possible, thereby maximizing returns for investors. Funds with no upfront fees allow more money to be invested from day one, permitting investors to reap the full benefits of compounded growth.”

To demonstrate the financial effect of upfront fees, take an example of R500,000 invested with Foord in a global balanced portfolio 20 years ago. “A 5.7% upfront charge (5% plus VAT - amounting to R28,500) would have cost the client an astounding R1.9 million in lost market value today, grown at our 20 year track record of 23.5% per annum,” says Cluer.

A low base fee with a performance element works for the benefit of the investor. “Primarily, performance based fees represent an alignment of interests between fund manager and investors. But they also mean that the manager can grow its revenues by focusing on investment performance rather than gathering assets.”

Cluer explains that Foord charges an annual service fee that is linked to the performance of the portfolio and has done since the inception of its flagship portfolios in 2002. The starting point is a standard charge rate, which is a fee for equalling the benchmark in terms of performance. ”Investors will only be charged this rate when we achieve a return that at least matches the benchmark return. Any under performance will result in the fee reducing. Of course, we will also share in any out performance we generate for clients.”

Critics of performance fees allege that they are an easy way for an asset manager to make money. Cluer disputes this.

“On the contrary, with a fixed basic fee arrangement, a rising market will increase the manager’s fees even if they underperform. With performance fees you have to work harder to generate additional fees – by adding manager specific return (alpha) over and above the market return (beta). This can be very difficult to achieve in an aggressive bull market, especially against an unbalanced index such as we have in South Africa. However, it is important that benchmarks are appropriate.”

To assess the relative benefits of performance fees, investors need to understand the benchmark. Weak or easily obtainable benchmarks achieve very little except to enrich the manager, says Cluer. “We believe the total return of the All Share Index is the most fitting equity benchmark. There have been many periods in the past where we have substantially outperformed the average equity fund – but under performed the index. Yet we haven’t charged performance related in fees, but in fact reduced our fees below the standard rate.”

Another criticism sometimes raised against performance fees is that they incentivize short term gains and encourage undue risks. Cluer acknowledges this is a possible side effect, but is an unlikely result if your manager has an established brand and long-term track record. “At Foord, our investment philosophy is premised on long-term, buy-and-hold investing and it would be highly unlikely that our process would be compromised for the sake of a potential short term gain.”

Many investors may question uncapped performance fees. Cluer notes that at Foord, “We specifically do not cap our fees. This is because we recognise that out performance isn’t achieved smoothly and that managers should participate in out performance on an as-and-when basis in the same way that their clients do. We counsel our investors to be patient in order to reap benefits in the long-term and we are similarly prepared to wait for our performance fees.”

When investors assess the costs involved in an investment, they should be aware that total expense ratio (TER) disclosure now reflects the total expense ratio in a unit trust fund. “Consequently, managers report the performance fee component separately which makes the assessment of cost much more transparent and accessible.”

To assess the relative benefits of performance fees, investors need to understand the benchmark. Weak or easily obtainable benchmarks achieve very little except to enrich the manager, says Cluer. “We believe the total return of the All Share Index is the most fitting equity benchmark. There have been many periods in the past where we have substantially outperformed the average equity fund – but under performed the index. Yet we haven’t charged performance related in fees, but in fact reduced our fees below the standard rate.”

Another criticism sometimes raised against performance fees is that they incentivize short term gains and encourage undue risks. Cluer acknowledges this is a possible side effect, but is an unlikely result if your manager has an established brand and long-term track record. “At Foord, our investment philosophy is premised on long-term, buy-and-hold investing and it would be highly unlikely that our process would be compromised for the sake of a potential short term gain.”

Many investors may question uncapped performance fees. Cluer notes that at Foord, “We specifically do not cap our fees. This is because we recognise that out performance isn’t achieved smoothly and that managers should participate in out performance on an as-and-when basis in the same way that their clients do. We counsel our investors to be patient in order to reap benefits in the long-term and we are similarly prepared to wait for our performance fees.”

When investors assess the costs involved in an investment, they should be aware that total expense ratio (TER) disclosure now reflects the total expense ratio in a unit trust fund. “Consequently, managers report the performance fee component separately which makes the assessment of cost much more transparent and accessible.”

“The current macro economic climate means that investors will be tightening their belts over the coming months, as well as looking for ways to preserve any profits their investments have generated in the roaring bull market of the past few years.”

Cluer says investors should be looking to put their money with investment houses whose fee structures don’t chew up the money available for investment. “Your asset manager should be trying to keep costs as low as possible, thereby maximizing returns for investors. Funds with no upfront fees allow more money to be invested from day one, permitting investors to reap the full benefits of compounded growth.”

To demonstrate the financial effect of upfront fees, take an example of R500,000 invested with Foord in a global balanced portfolio 20 years ago. “A 5.7% upfront charge (5% plus VAT - amounting to R28,500) would have cost the client an astounding R1.9 million in lost market value today, grown at our 20 year track record of 23.5% per annum,” says Cluer.

A low base fee with a performance element works for the benefit of the investor. “Primarily, performance based fees represent an alignment of interests between fund manager and investors. But they also mean that the manager can grow its revenues by focusing on investment performance rather than gathering assets.”

Cluer explains that Foord charges an annual service fee that is linked to the performance of the portfolio and has done since the inception of its flagship portfolios in 2002. The starting point is a standard charge rate, which is a fee for equalling the benchmark in terms of performance. ”Investors will only be charged this rate when we achieve a return that at least matches the benchmark return. Any under performance will result in the fee reducing. Of course, we will also share in any out performance we generate for clients.”

Critics of performance fees allege that they are an easy way for an asset manager to make money. Cluer disputes this.

“On the contrary, with a fixed basic fee arrangement, a rising market will increase the manager’s fees even if they underperform. With performance fees you have to work harder to generate additional fees – by adding manager specific return (alpha) over and above the market return (beta). This can be very difficult to achieve in an aggressive bull market, especially against an unbalanced index such as we have in South Africa. However, it is important that benchmarks are appropriate.”

To assess the relative benefits of performance fees, investors need to understand the benchmark. Weak or easily obtainable benchmarks achieve very little except to enrich the manager, says Cluer. “We believe the total return of the All Share Index is the most fitting equity benchmark. There have been many periods in the past where we have substantially outperformed the average equity fund – but under performed the index. Yet we haven’t charged performance related in fees, but in fact reduced our fees below the standard rate.”

Another criticism sometimes raised against performance fees is that they incentivize short term gains and encourage undue risks. Cluer acknowledges this is a possible side effect, but is an unlikely result if your manager has an established brand and long-term track record. “At Foord, our investment philosophy is premised on long-term, buy-and-hold investing and it would be highly unlikely that our process would be compromised for the sake of a potential short term gain.”

Many investors may question uncapped performance fees. Cluer notes that at Foord, “We specifically do not cap our fees. This is because we recognise that out performance isn’t achieved smoothly and that managers should participate in out performance on an as-and-when basis in the same way that their clients do. We counsel our investors to be patient in order to reap benefits in the long-term and we are similarly prepared to wait for our performance fees.”

When investors assess the costs involved in an investment, they should be aware that total expense ratio (TER) disclosure now reflects the total expense ratio in a unit trust fund. “Consequently, managers report the performance fee component separately which makes the assessment of cost much more transparent and accessible.”

To assess the relative benefits of performance fees, investors need to understand the benchmark. Weak or easily obtainable benchmarks achieve very little except to enrich the manager, says Cluer. “We believe the total return of the All Share Index is the most fitting equity benchmark. There have been many periods in the past where we have substantially outperformed the average equity fund – but under performed the index. Yet we haven’t charged performance related in fees, but in fact reduced our fees below the standard rate.”

Another criticism sometimes raised against performance fees is that they incentivize short term gains and encourage undue risks. Cluer acknowledges this is a possible side effect, but is an unlikely result if your manager has an established brand and long-term track record. “At Foord, our investment philosophy is premised on long-term, buy-and-hold investing and it would be highly unlikely that our process would be compromised for the sake of a potential short term gain.”

Many investors may question uncapped performance fees. Cluer notes that at Foord, “We specifically do not cap our fees. This is because we recognise that out performance isn’t achieved smoothly and that managers should participate in out performance on an as-and-when basis in the same way that their clients do. We counsel our investors to be patient in order to reap benefits in the long-term and we are similarly prepared to wait for our performance fees.”

When investors assess the costs involved in an investment, they should be aware that total expense ratio (TER) disclosure now reflects the total expense ratio in a unit trust fund. “Consequently, managers report the performance fee component separately which makes the assessment of cost much more transparent and accessible.”