Double shot interview: Amanda Morrall talks to Morningstar's Chris Douglas about performance fees on KiwiSaver funds

By Amanda Morrall

Fearful of fees?

You should be. They add up.

Overtime, KiwiSaver members will see a not-insignificant portion of returns on their investment lost to their fund manager. (See our fee tool calculator here to find how much)

So why would you want to pay more for a performance fee? A performance fee could be 10-15% extra over what you already pay.

While only a handful of KiwiSaver providers charge a performance fee currently the Financial Markets Authority is looking to establish some parameters around just how much extra fund managers can carve out in fees in exchange for their investment nous. (See Amanda Morrall article on the  FMA's guidance note here).

Chris Douglas, co-head of research for Morningstar, said any steps taken to improve the transparency around performance fees were welcome.

He said the benchmarks against which performance fees were charged were very low in some cases, insuring easy profits for fund  managers already pocketing baseline fees.

"The whole idea about performance fees is the alignment. So the fund manager says if we do well, we'll get paid well and if we don't do well, we won't get paid as much. But there's a lot of variables within a performance fee. The most important variable for us is that you are going to be using a fund that charges a fee, the base management fee that you are being charged should be below average.''

The average fees on KiwiSavers, by peer groups, are as follows. (Click here for full details as reported by Morningstar in its Sept.30,2001 KiwiSaver survey).

*The estimated total fee is the sum of management, administrative and trustee fees.

Fisher Funds Management, Milford Asset Management and Superlife (the Gemino Fund) are among those that charge a performance fee on their growth/aggressive funds.

For a detailed breakdown of fees on Fisher Funds growth fund click here. For Milford's fees explained click here and Superlife's Gemino fund click here.

Some of the bigger providers who use underlining fund managers also pay a performance fee although it typically gets rolled into the baseline fees so is less obvious to the KiwiSaver member. That's something the FMA is looking to change and has mentioned specifically in its guidance note with respect to third parties.

Douglas emphasised the importance of good communication between KiwiSaver providers and their members.

Being informed is one thing, understanding is another. When it comes to how fund managers earn their performance fee, many KiwiSavers are in the dark about the technical aspects of how it is calculated.  Self-selecting benchmarks are a case in point, said Douglas.

In some cases, fund managers are using the 90-day cash rate as a benchmark against which to pay themselves a performance fee, using zero as a hurdle rate.

"I'm not too sure how far they'll (the FMA) go to setting the benchmark but what they're saying is that is it's got to be an appropriate benchmark. If you're in an equity-based fund, they've alluded to the fact that a cash-based benchmark is not appropriate.""

High water marks

The FMA also notes its expectation that providers will use high water marks as a criteria for performance fee.

Douglas explains:

"If a fund goes up in value and then it sells off, the fund has set a high water mark. The fund has to recapture that up to its last highest value before it can start collecting that value again. It's about making sure it gets back to its highest unit value before it start collecting a performance fee again."

Crystallisation periods are another component of performance fees that KiwiSaver members will want to be aware, said Douglas.

"That's the period in which the fund manager will actually collect the performance fee. They might say every three months we'll bank the performance fee that we earn from our clients.

"What we believe is that a crystallisation period of at least 12 months need to be put in place.''

In its research on performance fees in Australia, Morningstar found that about half of fund managers were using a period of between three to six months as their crystallisation period, something the research house objects to. (To read Morningstar's report on best practises for performance fees on managed funds click here).

"We think that rewards short-term mentality, that they're too focused on short-term gains,'' said Douglas.

So what should KiwiSavers watch for if they're in a fund that charges a performance fee?

"We believe if they are charging a performance fee there should be a lower base fee. There's no point in paying a typical base fee and then charging a performance on top of that because it becomes very expensive. The whole idea is that it's an alignment between the fund manager and the investor.''

Fulcrums

To equalise the relationship, Douglas said Morningstar would like to see a similar policy in place to what's been introduced on the mutual funds sector in the United States; something called a Fulcrum Performance Fee.

"What it essentially means is that if a fund manager charges a performance fee, and they do well, they share in the upside, but if they do poorly they also have to lower their fee on a proportionate basis as well back to investor.''

While the United States is unique among the managed fund sectors is terms of having a Fulcrum Fee, the FMA is looking at the potential of something similar.

Douglas said the FMA mentioned the possibility of introducing something similar for KiwiSaver.

Those wishing to submit feedback to the FMA on their guidance note on performance fees as eligible to do so until Dec.2. Click here to access a contact form for the FMA.