As new disclosure rules give Canadian investors a clearer picture of how much they pay in fees, some financial services firms have begun experimenting with alternative arrangements in which their paydays are more closely linked to how well — or poorly — their clients’ investments have performed.
As opposed to the traditional percentage levied on the amount of assets being managed these new structures include only charging fees when a portfolio outdoes an industry benchmark or refunding some or all unless basic targets are met.
The firms are hoping these performance-based fee structures will entice Canadian investors, particularly those experiencing sticker shock in the coming months.
“Money managers have been making fees based on assets, not results,” said Chris Ambridge, president of Provisus Wealth Management Limited, which has recently created a subsidiary to manage a new series of funds with an alternative fee structure. “So, what we’re saying is, here is a money manager that is prepared to put its money where its mouth is … don’t pay us unless we deliver.”
Annual investing statements for 2016, which are due out in the coming weeks, will be among the first to reflect regulatory changes, called Client Relationship Model Phase 2 and dubbed CRM2.
CRM2 requires that investment firms provide two separate reports outlining specifically how their clients’ portfolios have performed over time as well as the total compensation that has been paid as an actual dollar amount.
Dealers have until July 14, 2017 to comply, but many investors will receive these in early 2017 because most firms are providing the information on a calendar-year basis.
The new scrutiny on fees, plus a growing appetite for cheaper, passive investment options such as exchange-traded funds and robo advisors, have spurred on the alternative structures.
In May, Ambridge’s firm Provisus created a new company, Transcend, which charges its clients who have a minimum $50,000 invested a 0.25 per cent fee to cover the base cost of administering a family of funds.
“What we’re saying is, here is a money manager that is prepared to put its money where its mouth is … don’t pay us unless we deliver”
If the funds do not outperform a pre-set industry benchmark, the fees paid will be similar to traditional ETFs. But if the fund outperforms, then clients will pay a performance fee equal to 20 per cent of the performance of the fund above said benchmark.
And effective Jan. 1, Toronto-based TriDelta Financial wealth management firm is offering a “partnership fee” structure option for its clients with a minimum of $500,000 invested.
Under this plan, if clients see a return that is less than 3 per cent, traditional fees are refunded or partially refunded, says chief executive Ted Rechtshaffen, an occasional columnist for the Financial Post. If returns are between 3 per cent and 7 per cent, the traditional fee (generally between 1 and 1.5 per cent) applies. However, if returns are above 7 per cent, an additional partnership fee of between 1 and 3 per cent would apply, depending on how well the portfolio has done.
The partnership fee puts the advisor’s “skin in the game” and puts them on the “same side of the table” as the client, said Rechtshaffen.
“They go, ‘If I make 13 per cent, I don’t mind paying higher fees. I’ve been looked after. I don’t mind you being looked after. But what really pisses me off, is when I lose money and you’re still making money’,” he said.
Ken Kivenko, an investor advocate who is also a member of the Ontario Securities Commission Investor Advisory Panel, is skeptical of performance-based fees, which can incentivize portfolio managers to take on more risk.
“It’s worth a crack,” says Kivenko. “I wouldn’t buy it myself because I don’t believe any of these guys can beat the market any more. And if they do, it’s only because — with your money — they took high risk. Or they were lucky.”
Capping performance fees is one way to minimize risk taking, says Matthew Manara, director of the private client division at Avenue Investment Management Inc.
Since its inception in 2003, Avenue Investment has been offering its clients a discount on its fees for the following 12 months if even one penny is lost, he says. If returns are better than 10 per cent, the firm gets a performance fee of 10 per cent of the excess performance — but it is capped at 1 per cent, he says.
Kivenko recommends that investors that do take this route take a close look at the fee, the formula used, and scrutinize which benchmark is used to measure performance.
“Sometimes they use a benchmark, and you can’t find it and you don’t know what it is,” says Kivenko. “Or it’s so low it’s not an appropriate benchmark so they beat it.”
“What we’re saying is let’s give you (small) fees, we’ll try to add value, and if we do add value, then pay us”
Meanwhile, the costs of mutual funds and even ETF fees are coming down, Kivenko says.
“They have to compete with products that at one time were expensive but are getting less and less expensive by the month…. If the fee is very high, and they cut it in half, you still may be worse off than in an actively managed mutual fund.”
Ambridge argues that while ETF fees do tend to be lower, clients are getting less bang for their buck.
“For a client, it’s passive investment, low fees, but they aren’t going to add any value,” says Ambridge. “What we’re saying is let’s give you (small) fees, we’ll try to add value, and if we do add value, then pay us.”
Time will tell whether these performance-based fees are actually better for investors, says Rechtshaffen. If we are heading into a historically lower return environment, then opting for a partnership fee will be better for investors’ wallets. But if returns are robust, partnership fees will be the more expensive option, he says.
“We have confidence in our investment approach that it’s going to do well for clients,” he says. “We are basically putting our money where our mouth is. If we don’t think going to deliver performance for the average client of over 7 per cent, then why would we do this?”
Armina Ligaya | January 3, 2017