Investors Shun New Breed of ‘Fees on Performance’ Funds

For years, finance journalists and investors have decried the fact that underperforming fund managers receive their fees regardless of if they outperform the benchmark or not. There was a clamour for at least a part of the fees paid by investors to be linked to performance. Last year two funds with performance-based fee structures, one from Fidelity and the other from Allianz, were finally launched. But it turns out that in practise, investors are not so keen on the added complexity of performance-related fees when choosing funds. Both have attracted disappointing levels of capital.

The rise of cheaper, passive investments like index tracking funds over the last decade has combined with a number of studies showing a minority of active fund managers consistently beat their benchmark. The inevitable result has been a questioning of why investors should pay higher fees for investments that, on average, deliver poorer returns than passive index trackers. The response from Fidelity and Allianz was versions of some of their Europe-based funds that set base fees comparable to those of passive peers, only rising if and when they outperform.

Fidelity chair Abigail Johnson said at the time of the launch of the new fees structure that the company wished to more proactively align the interests of the managers of its active fund products with those of investors. Unfortunately, the response from those investing online in funds has been underwhelming. Of the 12 performance-based equivalents of popular Fidelity funds launched last year, nine have attracted less than £60,000 in capital. Five of those nine less than £4000. The biggest, a Luxembourg-domiciled global equity fund has pulled in £36 million. However, the fixed-fee version of the same fund managed £2.1 billion in assets. Of course, that capital was attracted over a number of years and the variable fee product was only launched last year. But the overall uptake must still count as disappointing.

Allianz’s five new variable fee products haven’t done any better. By the end of last year three had attracted less than £30,000 in capital each and the largest a little over £400,000. The same fund with a traditional fee structure manages £166 million. The data is provided by Morningstar.

Ironically, it appears that investors actually prefer simple, easily explainable fee structures that offer certainty even if they are less fair.  Variable fees also raise issues for online investment platforms that are obliged to simply and transparently list fees. As a result, the variable fee funds offered by Fidelity and Allianz are not listed on most retail-facing UK investment platforms. Wealth managers and advisors are also said to be hesitant to offer these funds to clients as they have to explain additional complexities and are concerned about clients being unhappy or confused when fees fluctuate.

Despite the disappointingly slow start both Fidelity and Allianz say they are committed to continuing their push towards offering funds with variable fee structures, in the interests of investors. While variable fee structure models may need tweaking there is evidence it will become a long term trend. The world’s largest pensions fund, Japan’s Government Pensions Investment Fund has recently moved to a variable fee model. But it looks like individual investors will need a little time to be convinced that fairer is better than simpler when it comes to fund fees.