Kiwisaver returns

June 7th, 2012 at 1:00 pm by David Farrar

The Herald reports:

A retirement policy expert says providers should not be allowed to publish investment performance returns based on gross figures because they are “meaningless” and cannot be easily compared.

Finance Minister Bill English announced as part of the Budget that all KiwiSaver providers will have to produce quarterly reports from April including information on investment performance, fees and assets.

A report gives an example of how the information would be set out, placing the gross return percentage at the top of a table, which would also include dollar figures on the gross return based on a $10,000 investment, as well as dollar figures for the tax and fees paid and an explanation of how much in the hand investors would get.

But Retirement Policy and Research Centre director Michael Littlewood said publicity that emphasised gross returns should not be permitted or, if published, they should be given a lower prominence over the net return.

“Gross returns are almost meaningless and are certainly not comparable across providers,” Littlewood said.

“Providers will naturally want to emphasise larger numbers, even if they are not meaningful.”

There is a lot of crappy info about KiwiSaver returns – especially from the self-appointed champion of transparency, and commentator on everything (you know who I mean).

Net returns are harder to do, but should be the default information provided. One can show them for various tax rates if necessary.

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41 Responses to “Kiwisaver returns”

  1. CJPhoto (221 comments) says:

    The after fees is the important part. They should just assume you are on the top rate and then if you are on a lower rate, they then are better off. The key point is that the measuring criteria needs to be consistent.

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  2. Grendel (1,002 comments) says:

    Being that Kiwisaver is meant to be a dollar cost averaged product over the long term, publishing year by year returns with all the hype media does misses the point of Kiwisaver.

    the year by year returns are irrelevant, and chasing last years winner has been shown to end up with a longer term lower return.

    whats more important about Kiwisaver is the continuous depositing of money over as long a time as possible, not focusing on small timeframe returns.

    However if returns are going to be published, then net returns are whats important, not gross returns.

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  3. virtualmark (1,523 comments) says:

    Net returns is the key thing for all investment funds to report. That, and portfolio allocation. All the rest … including gross returns, total expense ratios etc … is just noise.

    Probably best to require Kiwisaver funds to report net returns after expenses but pre-tax, and then alongside that headline figure provide a brief table showing the post-tax returns at the main tax rates.

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  4. Manolo (13,746 comments) says:

    Littlewood knows more, far more, than English on this matter.

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  5. Alan Johnstone (1,087 comments) says:

    Yes, it’s for the log term, but management fees are critical.

    That’s why it’s often better to go for a passively managed index tracker fund, than an actively managed one.

    Even if they get better returns, it’ll not cover the fees

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  6. virtualmark (1,523 comments) says:

    Alan Johnstone … the level of management fees is a red herring. Simple example:

    * Fund Manager A gets gross returns of 10% pa, charges fees & expenses of 1% pa, and so delivers a net return of 9% pa.
    * Fund Manager B gets gross returns of 13% pa, charges fees & expenses of 2% pa, and so delivers a net return of 11% pa.

    Fund Manager B charges twice the level of fees that Fund Manager A does. The greedy bastard! Why on earth would I want to put my money with Fund Manager B?

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  7. Alan Johnstone (1,087 comments) says:

    VM, it’s not a red herring, because there are no fund managers (Warren Buffett perhaps excepted) that regularly beat benchmark indexes.

    Fund Manager B in your example doesn’t exist, the evidence of the last 40 years proves this.

    I’ve looked at the record of managed funds (mostly in the US & Europe but I have no reason to think NZ is different), there are pretty much zero that beat passively managed funds over the long term when the higher fees are taken into account.

    If I get time I’ll dig out the sources for this later. Please feel free to post stats showing I’m wrong.

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  8. Paulus (2,626 comments) says:

    Littlewood comes from the Life Insurance Industry, who are as irresponsible in managing other people’s money as Kiwisaver providers. Cost me big six figures in real actual capital loss.
    I see that the great Gareth Morgan agrees with him – look at Morgan’s known returns under Kiwisaver – why place your money with his or any organisation, until you can see the realistic returns first.

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  9. slijmbal (1,236 comments) says:

    Alan Johnstone is mostly correct

    The long term evidence across many sharemarkets is that < 20% of funds managers beat the appropriate index. If we then allow for fees that number drops. Fees are a major killer and is why I have a substantial amount of my investments in ETFs that track indices and have very low overheads.

    As much as Gareth Morgan gets on my tits with his public persona his funds are the most transparent out there and his complaints around poor rating systems from the likes of Morningstar are accurate. He is also transparent in terms of telling you what index he aims to beat and he generally beats it. If his returns are poor it is because that index has poor returns.

    NZ has a poor regulatory system wrt to investments and there are many ways to hide fees/costs.

    Several of the default Kiwisaver providers invest in their own products and are thus able to hide fees as they are one stage removed. Their kiwisaver customers might lose them money because of the need to keep fees down (and several do) but many more than make up for it by investing via their own products.

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  10. Kimble (4,438 comments) says:

    Then the next year…

    * Fund Manager A gets gross returns of 13% pa, charges fees & expenses of 1% pa, and so delivers a net return of 12% pa.
    * Fund Manager B gets gross returns of 10% pa, charges fees & expenses of 2% pa, and so delivers a net return of 8% pa.

    Over the two years Manager A produced 10.5%pa.
    Over the two years Manager B produced 9.5%pa.

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  11. virtualmark (1,523 comments) says:

    Alan, Kimble,

    VM, it’s not a red herring, because there are no fund managers (Warren Buffett perhaps excepted) that regularly beat benchmark indexes.

    Kind of true, kind of not. If you do believe that no fund manager consistently delivers alpha then by all means you should invest in a passive index tracking fund, and since those funds require no smarts – and so don’t have to remunerate smart people – you should look for the one with the lowest fees.

    And when I look across the universe of Kiwisaver providers I can well understand why you might think none of them are likely to consistently deliver alpha.

    But, then again, I run an absolute return fund. Our returns well exceed the benchmark indexes. Consistently. Our fees well exceed the normal “1% of FuM pa” too. But, that said, we don’t start charging a fee – any fee – until investors get a 6% pa return (logic being that investors can take simple straightforward steps themselves and get a 6% return, so we should only be remunerated if we can improve on that).

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  12. virtualmark (1,523 comments) says:

    Kimble, the key questions are …

    1. Are there smarter fund managers out there who will consistently get best-of-class returns?
    2. If there are, then can I identify who those smarter fund managers are and put my money with them?

    The answer to question 1 is definitely yes. The answer to question 2 is … probably, if you are in the industry and know what you’re doing, but if you are a regular punter then no, it’s unlikely you’ll be able to figure out who the good managers are. And, complicating the answer to question 2, the good managers are unlikely to be managing large publicly-accessible funds, such as Kiwisaver.

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  13. Kimble (4,438 comments) says:

    1. Are there smarter fund managers out there who will consistently get best-of-class returns?

    Managers who consistently make the most aren’t necessarily the smartest. There are people who can end up topping the list year after year, but the law of large numbers make this less remarkable than it first seems.

    What at first may seem like demonstrated skill, could simply be that you have been fooled by randomness.

    1. Do you earn back any losses before you start charging your fee again? Or do you simply reset the game every year?
    2. How many years in a row could you afford to under-perform your target and still remain in business?
    3. If you are close to the end of that time-frame and you are still well under water, how will the management of your funds change? Will you take on more risk than you would have if you were financially secure?

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  14. Alan Johnstone (1,087 comments) says:

    I guess that’s the point of an actively managed fund; the fund manager has skin in the game.

    Does that encourage him to make the best decisions ?

    I really don’t know the answer to that question, I can make a case to myself either way. Depends on your risk profile as well I guess.

    If we accept that 90% of funds don’t do better over the long term and most average people like me couldn’t pick them anyway or afford them, then getting the lowest management fees is the critical choice as a 1% difference in returns annually compounds to a vast sum of money over the 40 year term that most retirement funds are invested over.

    Thanks for every ones views. Been informative for me.

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  15. Kimble (4,438 comments) says:

    I guess that’s the point of an actively managed fund; the fund manager has skin in the game.

    Few managers of actively managed funds have skin in the game. Did you mean absolute return? Or just managers that have a performance fee?

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  16. virtualmark (1,523 comments) says:

    Kimble,

    Managers who consistently make the most aren’t necessarily the smartest. There are people who can end up topping the list year after year, but the law of large numbers make this less remarkable than it first seems.

    Kind of. Any given strategy will suit certain market conditions, so a manager with “strategy X” will do well some years and not so well in other years, just because the market conditions move. Simple example is that cash/bond funds do well in bad years, while equities crash, and then equity-led strategies do well in bull markets while cash/bond returns look pretty unspectacular.

    The smart people look to develop a strategy that’s optimised across the economic cycle, rather than for any one piece of the economic cycle. The downside of that is that such a strategy probably won’t be the best returner in any one year (since it’s actually optimised for the whole cycle, rather than just one year) but it will be the best in the long run.

    Lesson being … don’t worry too much about topping the class in any one year. And don’t expect the best people are those who’ve actually topped the class in any year at all.

    1. Do you earn back any losses before you start charging your fee again? Or do you simply reset the game every year?

    We have a high tide mark. Personally I think they’re a negative move and act against investors interests. But investors think they’re important, so we have one. We don’t reset our high tide mark.

    2. How many years in a row could you afford to under-perform your target and still remain in business?

    We work on the basis that one year in three we’ll have little or no fee income. We got no fee income in the last year. But we can survive quite a long time without fees though, several years.

    3. If you are close to the end of that time-frame and you are still well under water, how will the management of your funds change? Will you take on more risk than you would have if you were financially secure?

    Our investment strategy & investment approach doesn’t/wouldn’t/can’t change. It wouldn’t lead us to take on more risk.

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  17. Alan Johnstone (1,087 comments) says:

    Kimble,

    I mean two things, performance fees but more importantly their position on league tables which drives the inflow (good) or outflow (v bad) of money from their companies.

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  18. WineOh (630 comments) says:

    “I guess that’s the point of an actively managed fund; the fund manager has skin in the game”

    But they don’t…. thats the point isn’t it? The active fund manager is still paid based on a percentage of funds under investment, not the actual return.

    I agree with others that the net return is the only part that really matters, but seems to be the one that is obscured by the fund managers. And its really not that hard to calculate! A second year liberal arts student could probably figure it out on a spreadsheet if given the numbers.

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  19. Kimble (4,438 comments) says:

    Oops, I missed one important question:

    4. 6% may be when you start charging a fee, but is that fee for returns in excess of 6% or do they include the 6%?

    Personally I think they’re a negative move and act against investors interests.

    In what way would not charging a performance fee for recouping the losses you were responsible for be against the interests of investors?

    If you lose 25%, why should you be patted on the back when you make 25% the next year? The investor is still making a loss, but you are crowing about beating your benchmark by 19%?

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  20. virtualmark (1,523 comments) says:

    Kimble,

    6% may be when you start charging a fee, but is that fee for returns in excess of 6% or do they include the 6%?

    Our performance fee is based on returns in excess of 6%. Our philosophy is that investors should be able to get 6% pa without needing anyone’s help. But if we’re smart people who can get higher returns than that then we deserve a share of that higher return we create.

    In what way would not charging a performance fee for recouping the losses you were responsible for be against the interests of investors?

    Two things.

    Firstly, investors need to man up and realize that sometimes the value of an investment declines, no matter what the manager does. Just because a fund might have losses doesn’t mean the manager is responsible for that. If a listed fund loses 5% one year, but the major indexes have lost 15% then did the manager do a bad job? Penalising them just makes the investors look like unreasonable gits.

    If investors want the chance to get the high returns from riskier investments then they need to be mature enough to realize there’s a downside risk too. I have no problem with a high tide mark that’s based on the movement of an underlying index or reference. But just basing it on the fund’s performance is philosophically cheap.

    Secondly, if the high tide mark becomes too punitive then it becomes rational for the manager to do things that might not serve the investors long-term interests. For example, if we had a high tide mark that became out of reach then we’d look to flush the old investors out (i.e. the investors who have the high tide mark). A new investor coming in isn’t subject to the high tide mark – so our incentive is to redeem the old investors and move on. Other funds, with different structures, are incentivised to really roll the dice and take on riskier positions.

    Ultimately high tide marks (and fee caps too, there’s another short-sighted measure) just incentivise managers to look to break away from the investors. They might look like good measures on the surface, but with deeper thought they’re not actually in investors’ best interests.

    At the end of it, the ultimate sanction an investor has is to withdraw their money and take it somewhere else. If you don’t think your manager is any good then go somewhere else. That’s the real sword hanging over the manager’s neck.

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  21. cows4me (248 comments) says:

    I only have one problem with fund managers and it’s the same problem i have with with farm advisers. If you were a top fund manager why do you not grow your own capital, or is sharing your ability to make wealth only good if you use someones else wealth, or through the love of your fallow man you feel compelled to save him from stupid investments ?. Personally I believe that we should invest in our own interests and have on several occasions clashed with “fund mangers” , I still prevail, some are now in the employ at WINZ

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  22. virtualmark (1,523 comments) says:

    cows4me,

    An increasingly large portion of our fund is made up of the manager’s money. But we have to earn a living too, and like everyone else we sell our expertise to others to earn a living. No conspiracy in that, it’s just the way the world works.

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  23. cows4me (248 comments) says:

    No problem virtualmark and sorry if I offend you. I probably have a bad attitude to life, my attitude is to look after myself and my kin. I saved many years in a fund when i was younger. I have no real problem with the fund managers or how they invested my money , very nice people. My problem came when I wanted to withdraw my money to buy a farm. Shit more excuses then a dog can piss in one day. I made money but that was what I was promised. I see the world now and say fuck how do you insure your wealth. For me I have no choice Fonterra, land, animals, but I do not wish for anything different.People in town are screwed especially the old people, interest rates flat, I struggle to see how money can be made these days, oops you could always buy facebook LOL

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  24. Michael Mckee (1,091 comments) says:

    Does it really matter what we’ve got saved if all the derivitives Govts have fall over?
    http://www.scoop.co.nz/stories/PO1206/S00031/governments-huge-derivatives-exposure-needs-public-scrutiny.htm
    http://www.washingtonsblog.com/2012/05/top-derivatives-expert-finally-gives-a-credible-estimate-of-the-size-of-the-global-derivatives-market.html

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  25. Kimble (4,438 comments) says:

    Firstly, investors need to man up and realize that sometimes the value of an investment declines, no matter what the manager does.

    Whoa there! Sometimes the value of an investment GAINS no matter what the manager does, and you guys are getting paid for that.

    I agree that investors in NZ need to accept that even a good manager can lose money, and still have done a good job. And also that a performance fee relative to a benchmark should have a benchmark related high water mark. Neither of those points are arguments against a high water mark.

    Secondly, if the high tide mark becomes too punitive then it becomes rational for the manager to do things that might not serve the investors long-term interests.

    Which MAY be a problem for strategies that have very wide mandates, like an absolute return fund. But your standard funds will have portfolio limits which restrict how crazy a manager can get.

    A new investor coming in isn’t subject to the high tide mark – so our incentive is to redeem the old investors and move on.

    Or you could close the fund altogether, move country and start again. I dont see much difference between the two actions. Better hope your history of poor performance (and your less than sterling behaviour afterwards) doesnt find a way to catch up to you.

    The issue here is that you reckon it is in investors best interests if the market returns to its original value after losing a ton, that you guys should get paid for the recovery.

    I am sure you are ethical in your dealings. But it seems a less ethical person could take risks with the portfolio, if it pays off, they get paid, if it doesnt, they just let it ride. They now can hope for some mean reversion to earn them their fee.

    Some Maddoff wannabe clown could run the strategy for a few years, get some whales through the door, then take a massive punt on a huge return.

    Someone independently wealthy could require funds were locked in for 10-15 years, invest the funds in a diversified ETF, then claim 25% of the equity risk premium for doing nothing.

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  26. Kimble (4,438 comments) says:

    Specifically, Paul Wilmott – who has written numerous books on the subject – estimated the number last year at $1.2 quadrillion.

    Michael Mckee, that is a story built on big numbers. It is a function of activity not exposure. Netting out the contracts reduces the number to something less than impressive. Why did they focus on the big number? Thats usually my first clue that there isnt a story in the real numbers.

    The only stories there are that counter-party risk exist (which, if its priced correctly, isnt much of an issue) and the way under-estimation of counter-party risk (or the over-estimation of safety) can lead to poor investment decisions.

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  27. slijmbal (1,236 comments) says:

    @virtual

    if your fund charges fees in the manner which you describe then it is very definitely not the usual mechanism. Most charge by amount of funds held. One reason smaller funds invariably close even when they perform well. The research in terms of publicly available investments/funds is unequivocal. By the time fees are taken in to account they just don’t cut it in comparison to the indices in the long term. There are exceptions but some people win the lottery as well. Chance plays a part.

    I’ve managed to beat the returns of pretty much of every investment manager, funds advisor, etc that I’ve spoken to in the last 20 years. I’ve also had periods of years of negative to minimal gain. That’s because I can make significant decisions that most aren’t geared to make. For instance, I got out of majority of equities before the last crash, made a chunk in buying bonds when interest rates were higher and selling out for capital gain, saw the flight to safety and bought gold at < 1/2 the price it is now. I'm currently slowly moving back in to various equity investments as still pretty cashed up and doing a play on the US vs NZ $ and also reckon time to get out of gold soon but gold itself is mainly a US$ play at the moment so I may not for a while.

    These all sound simple but I've yet to see any funds manager, investment advisor actually really work to make me money – they sell a strategy and leave it at that. Even most of the hedge funds are a waste of space because of excessive fees – I worked out if they're listed one made more money from owning their shares than buying in to their investments. Many relied on overly idealistic investment models and many get badly burnt by the inevitable black swan events.

    I've spent much time researching, reading, investigating this stuff as I figured that once my savings were above a certain amount they were actually more important than my salary and needed appropriate care and attention. One thing has struck me. NZ is a bit of a wild west in terms of honesty and transparency. Many so called advisors peddle products they know are flawed. Anything to improve that is desirable.

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  28. Kimble (4,438 comments) says:

    I’ve managed to beat the returns of pretty much of every investment manager, funds advisor, etc that I’ve spoken to in the last 20 years.

    Wait for it…

    I got out of majority of equities before the last crash, made a chunk in buying bonds…

    Must be nice to have such a wide mandate that you can change your allocation 100%. Though I’d be a little cheesed off if my bond guy decided to invest in emerging market equities.

    Fairly, the only investment managers you can compare yourself to would be those with an equally wide mandate and few restrictions on their portfolio (i.e. no risk department). So hedge fund managers.

    Definitely not investment managers who invest in diversified portfolios, nor advisers who generally do the same (or who, at the very least, must consider the risk profile of their clients, indeed, who ought to hold the idea paramount).

    Even most of the hedge funds are a waste of space because of excessive fees – I worked out if they’re listed one made more money from owning their shares than buying in to their investments.

    Huh? How many hedge fund managers are listed? I dont recall that many right at the moment, let alone the number you would have required to be able to spot a pattern. Certainly when the one I remember most clearly, the one time largest in the world, is down 90% from its peak.

    Many relied on overly idealistic investment models and many get badly burnt by the inevitable black swan events.

    Something you will never have to worry about, jumping from asset class to asset class, following a perpetually concentrated strategy. Black swans always land on placid lakes, that’s the predictable thing about them.

    cows4me said,

    If you were a top fund manager why do you not grow your own capital,

    Well, I present to you… slijmbal; someone who has beaten the crap out of investment managers and advisers for 20 years. Still, if he had the gumption to go into investment management early on (i.e. if he had the foresight to appreciate his own talent for market timing) he may have been sitting with these guys.

    http://www.wsws.org/articles/2007/apr2007/hedg-a27.shtml

    Going to disparage them, cows4me, for investing other peoples money?

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  29. virtualmark (1,523 comments) says:

    Kimble,

    Whoa there! Sometimes the value of an investment GAINS no matter what the manager does, and you guys are getting paid for that.

    Yes, but remember we have to get performance beyond some hurdle before we get paid, and one role of the hurdle is to say “This is the return I could get anyway, from a rising market, so you’re only getting paid if you do better than that”.

    To be clear … I am okay with high water marks, but I strongly suggest that (i) performance fees should be linked to exceeding a hurdle or index and (ii) the high water mark should to be linked to that same hurdle or index.

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  30. virtualmark (1,523 comments) says:

    slijmbal,

    You need to keep in mind that there’s a big difference between an individual investing their own money and a manager running a fund. Two simple examples:

    1. When you’re managing your own money you intrinsically know your appetite for risk. And, typically, individuals seem to be comfortable taking on levels of investment risk that a professional couldn’t get away with – my experience is that individuals will invest in edgier stuff, and they will concentrate their investment portfolio into a small number of investments in a way most managers simply wouldn’t be able to.
    2. Individuals typically manage much smaller amounts of money, which makes it practical for them to invest in a wider range of options. Example: Funds typically can’t efficiently invest in small caps, because those stocks just aren’t liquid enough for the size of the investments the fund would have to make.

    Trust me, every fund manager will tell you it’s much harder maintaining good returns as the size of your fund gets bigger.

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  31. Kimble (4,438 comments) says:

    Yes, but remember we have to get performance beyond some hurdle before we get paid,

    Your hurdle is the risk free rate. You are getting paid for taking market risk. Given that the expected return of risky assets is higher than the risk free rate (its called the risk premium), you are essentially taking credit for exposure the investor could have gotten simply by investing in risky assets themselves.

    To be clear, if you simply invested in an ETF, and the market tanks 25% in a month, the subsequent recovery over the next year would have you earning around 4% of investors money (assuming 25% perf fee) without actually doing anything.

    Now your strategy obviously requires market timing, and you want to get paid for that service, but I get the feeling your fee on all upside is there to offset the lack of fee on the downside.

    Over the long term, if you are investing in risky assets and so would expect a 3-4% risk premium, you guys would be averaging 1% per year, for market return.

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  32. Kimble (4,438 comments) says:

    The more common role of the hurdle is to accommodate the base fee, another is to differentiate between weak alpha and significant alpha. The benchmark is usually there to represent the “opportunity cost”. For an equity fund, it is the market return. The argument is that for an absolute return fund, it should be an absolute benchmark. But it really should be an absolute BM plus a risk premium.

    It seems you guys dont have a premium, in exchange for not collecting any fees on the downside, rather than because it is morally justified.

    No problem with that, its a business decision, I am sure your investors love it. Though they may not realise the cost over the long term.

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  33. virtualmark (1,523 comments) says:

    Kimble,

    As you say, our fee philosophy is to benchmark against the risk free rate, with 6% pa being a proxy for that (it’s simpler to use a single constant figure than to keep varying the risk free rate as things like Government bond rates move).

    Also, as you say, investors could invest in riskier assets themselves. Many do. And I’d suggest it wouldn’t be controversial for those investors to expect to average 10-12% pa over the long run from their riskier assets. (note: all figures pre-tax).

    Investors choose to invest in vehicles like ours because (i) they think we can deliver them long-run returns greater than that 10-12% pa, even after our fees come out and/or (ii) they think we can deliver them less volatility than they’d receive themselves. If we can’t deliver on that then, rationally, we’d expect investors to withdraw their money. We’re grown ups, we understand that’s the dynamic.

    Our fee proposition is simple. We don’t get remunerated for achieving risk-free returns or worse. We do get a share of anything above that. And if we don’t deliver a sufficient premium above the risk-free rate then sure, we expect investors will withdraw.

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  34. Kimble (4,438 comments) says:

    25% of everything above cash? 10%? 50%? I will assume 25%.

    Lets compare your fund’s structure to a normal risky fund. A performance fee of 25% under your structure would earn a normal 1% fee when the fund reaches 10% after-fee performance. That would cover a risk premium, so in effect, assuming you are investing in risky assets over the long term, your fund is expected to earn a fee comparable to a management fee of other fund companies.

    For returns above 10%, your fund would operate as if it had a 1% base fee, and 25% performance fee for the returns above 10%. When your fund performance falls, you start giving back the performance fee until it is exhausted.

    For returns below 10% but above 6%, as you have already returned the performance fee you start refunding your management fee. The management fee provides a floor on the manager’s liability. Below 6% all losses are the investors alone.

    This sounds remarkably like a fulcrum fee structure, found mostly in the US.

    http://www.investopedia.com/terms/f/fulcrumfee.asp#axzz1x9vbStgl

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  35. virtualmark (1,523 comments) says:

    Kimble,

    Loosely yes, that’s one way you could look at it. But it brings us back to the core point of the original comments on this thread … investors shouldn’t fixate on the fee, they should focus on the net return.

    We are very realistic that as long as we provide attractive net returns then investors will invest with us, and if we can’t continue to deliver great net returns then they will leave.

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  36. Kimble (4,438 comments) says:

    …investors shouldn’t fixate on the fee, they should focus on the net return.

    Sorry, cant agree.

    For prospective investors, the net return offers no indication of future returns. The fee does.
    For existing investors, the net return is a nice record of what has been earned, but again, not certain next year. For most investors the only certainty is the fee.

    Which is the better maxim? The fund with the better net return is the better investment, or, the fund with the lower fee is the better investment.

    In a world of uncertainty, the fee is the only certainty (bizarre structures aside).

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  37. slijmbal (1,236 comments) says:

    @vm and kimble

    vm – as I understand it the fee structure you state is better than the norm as the norm is basically clipping the ticket regardless of performance and as mentioned earlier few actually perform. As you said larger funds basically struggle to make decent returns but smaller funds with better returns often get wound up as they don’t generate fees for the manager. The investment funds market is driven by volume and thus marketing. If you cannot get the volumes of investors then …..

    And yes I can make decisions no manager seems willing to make but then I’m not a professional and I don’t get why they don’t as many are reasonably obvious even to a layman like myself.

    When I checked 3->4 hedge funds had listed management companies (from memory – checked about 5 years ago). Based on my investigations their funds really did not seem worth in investing in as they had humongous fees. Their share price seemed to give better returns than their funds at the time. Anyone who won’t really tell me their investment strategy doesn’t get my money and most of the hedge funds work on the ‘we have magic fairy dust’ principle. It’s pretty much a ‘trust me’ sell.

    In terms of risk – I spread my investments as per modern portfolio theory as it seems pretty bleeding obvious. But I do manage my ‘mix’ to accommodate market cycles. I also understand that something like 80% of return is based on the type of investment and not a specific company e.g. oil companies tend to do well (or not) as a group. I don’t trade and my average holding time would be 5 years plus. Fees are the killer. ETFs that own the underlying investments and don’t use derivatives provide a decent backbone and plenty of diversification. I do also target specific high risk/high reward type investments with a smaller percentage of my investments and have either been lucky or have decent judgement as overall they have provided pretty good returns. It is not hard to make money with a decent 10 year warrant on an Ozzie bank for instance. A bit of dollar cost averaging with low fee index funds rounds it off.

    It is also a truism that small cap and value investments tend to beat the market long term but have volatility. This volatility translates to inability to increase fund sizes as most investors don’t really understand investing and struggle to cope with understanding losses. There are several small cap ETFs though.

    In terms of fees – I tend to agree with vm – net return is what matters IF the fees are not silly. I have repeatedly asked many advisors whether their fees would follow my returns and yet to meet one who didn’t clip the ticket and refused to back their abilities and share risk/reward. Vm is the exception. The clip the ticket approach does not encourage performance. It encourages sales and marketing. At least many of the index funds compete on fees.

    In summary, the vast majority of the investment market/funds advisors etc don’t appear to provide a lot of value and it’s arguable they reduce returns through excessive fees for no real service. Many of the banks kiwisaver funds are pretty nasty in that respect as they only need to report on the funds’ fees and not the hidden fees they have by investing in their own funds, which often invest via other wholesale funds. There can be up to 4 or 5 entities clipping the ticket and no wonder it’s hard to beat the appropriate index.

    I’m underwhelmed

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  38. Johnboy (16,495 comments) says:

    Hell not all fund managers have the benefit of an Oxford education and a nice armchair! :)

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  39. Kimble (4,438 comments) says:

    The clip the ticket approach does not encourage performance.

    It doesnt have to. Retaining your investment to clip the ticket in the future provides enough incentive. Nobody chooses mediocrity, managers all try to add value.

    There is little correlation on the upside between fees and performance. And there is also little evidence that performance fees result in better performance.

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  40. slijmbal (1,236 comments) says:

    “There is little correlation on the upside between fees and performance. And there is also little evidence that performance fees result in better performance”

    I’m going the other way – at least if they don’t perform they take less of my money. Whether they have a performance based fee or not will not make a difference to retaining customers if their fund tanks so the fees do not matter in that respect.

    However, there IS significant correlation between fees and net performance to the poor investor. There have been several studies on this (and no – I don’t have links to hand). Funds that charge greater fees generally return less to the investor – full stop. Many investments actually eat up the majority of gains in various fees.

    “Nobody chooses mediocrity, managers all try to add value.” Yes – but that’s often not that important – many funds are devised on their ability to be sold and match the latest trend. They are sold even if the manager is aware that they are likely to underperform because of the behaviour of the specific ‘flavour’ of investment sold or timing in the market cycle. It is not uncommon to see a new fund/trust appear after a specific part of the market has performed well and as we all know that is the most likely time for underperformance for most investments. The manager will obviously try to add some value but if the nature of the investment means it is inappropriate to be investing in it at that time they cannot really do much about it. To be fair that is as much about the stupidity of the average investor chasing the last best thing but performance based fees would tend to put a stop to that.

    I stand by my comment that clipping the ticket does not encourage performance – it encourages sales. 20+ years of watching various investments being established based on trend X and watching what gets dis-established or not has utterly convinced me of this. I have frequently seen poorly performing (long term) investments continue but well performing smaller funds being scrapped as they just did not have a large enough base of investors.

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  41. Kimble (4,438 comments) says:

    I’m going the other way – at least if they don’t perform they take less of my money.

    You are assuming that the base fee (which practically everyone charges) is reduced when a performance fee is introduced. Thats a brave assumption.

    Whether they have a performance based fee or not will not make a difference to retaining customers if their fund tanks so the fees do not matter in that respect.

    If you are in the fund when it tanks then you have already made your decision on the fees. You have shown your willingness to pay them. Fees matter from the perspective of an investor in the year before the fund tanked. A good fee doesnt make a bad manager good, but while most people cant tell a bad manager from a good one, they should all be able to tell a bad fee from a good one. And as there is little correlation between fees and manager skill on the upside, focussing on fees will help you whether you choose a bad manager or a good one.

    To be fair that is as much about the stupidity of the average investor chasing the last best thing but performance based fees would tend to put a stop to that.

    And here you are assuming that the investment manager isnt also falling for ‘the next big thing’. If performance fees were made mandatory, I dont think this phenomena would disappear.

    I stand by my comment that clipping the ticket does not encourage performance – it encourages sales.

    1. It isnt intended to encourage performance (directly).
    2. Performance fees dont result in greater returns.
    3. Sales doesnt affect investing (discounting a capacity issue).
    4. Funds chasing fads will always be created.

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