Golden rules for performance fees

Fund managers should reduce their dependence on fees and instead rely more on outperformance for their income and align their interests with investors, according to a survey by Australian Unity Investments (AUI).

The financial services company quizzed advisers while developing its high conviction retail equity fund with joint venture partner Platypus, and came up with four key principles for performance fees.

Firstly, AUI established that the net return to the investor must always be positive, meaning that it is still possible for a manager to deliver a negative return despite having outperformed the index significantly.

It was also found that performance fees should only be paid based on net outperformance, after management expense ratio.

Referring to fixed management fees for funds with a performance fee, AUI said these should be set lower for new products and reduced for existing funds.

“We believe that fund managers must sacrifice some of their fee security and depend on their outperformance for a portion of their income, better aligning their interests with those of investors,” David Bryant, head of AUI, said.

Using the example of Platypus, he said that it only charges a 0.95 per cent fixed fee, which sacrifices around 35 per cent of AUI’s total fee to performance risk.

Last but not least, the survey found that in order to justify performance fees, a fund must have a demonstrable history of strong performance.

“Investors are not looking for the lowest fees, they’re looking for the best net outperformance over the life of their investment within their risk profile.

“Performance fees that form part of a reasonable total fee can serve investors better than a flat fee that is paid regardless of performance,” Bryant said.