NZ investors 'paying too much in performance fees'

Performance fees for investment managers is emerging as a key issue as the sector faces lower returns and investors become smarter.

"Retail investors may be paying too much in performance fees, or even worse, paying a performance fee when comparable market performance has not even been achieved," says a study by Harbour Asset Management.

The study focuses on performance fees as opposed to the base fees which most vehicles charge. The study takes much of its cue from the Morningstar review of Australian managed funds last year.

The Harbour study also emphasises many similar issues to those raised by the Financial Markets Authority in November last year, although Harbour's portfolio manager Andrew Bascand said the FMA "guidance note" came six months after Harbour began looking at the issue.

The key issues are not only around disclosure of performance fees but the nature of those fees. (Performance fees are essentially a "bonus" for good performance.)

Some tricks include setting a benchmark for the performance fee at a lower asset class than the class actually being invested in - a typical example is cash as a benchmark when the investment is equities.

The Harbour study shows out of 12 funds investing in equities only two had a benchmark relative to equities, while seven had a cash benchmark and three had an "absolute" benchmark. A second trick is to have a "high water mark" that is re-set at regular intervals rather than being in perpetuity.

For example, with an investment of $100,000 which loses $5000 in value in that first year if the high water mark is re-set again at the start of the next year the fund manager does not have to recoup that loss before performance fees can be collected again but rather the high water mark drops to $95,000.

The Harbour study shows that one out of 18 New Zealand funds have a perpetual high water mark - including Harbour itself. Morningstar guidelines also suggest fund managers' performance fees would have a "hurdle" of an added value above a certain percentage point to receive an extra performance fee and also have the fees capped at a certain percentage.

Only one fund manager had this and two of the 12 the fee structure could not be determined, said Harbour's chief operating officer Jody Kaye.

That highlighted another issue - the difficulty in finding clear information about performance fees, he said.

"I've been in the industry for 18 years and I could not work it out. You got to question whether this meets the disclosure regulations."

There are other issues around what is disclosed to investors, he said.

For most funds only the basis for the performance fee is provided, not the actual historical performance fees charged - as happens in Australia.

New Zealand's FMA released a set of guidelines in November but these do not have any real teeth, Mr Bascand said. "Its not clear to me where the stick is. There's no real sanction there, its just a slap on the wrist."

Issues of how much investors are paying in fees are likely to become much more salient as the sector becomes more competitive - and as investors become more knowledgeable about how investments actually work.

A further driver is the fact that as the era of high returns of now appears to be over the amount investors are paying in fees is taking a higher real proportion out of investment returns, especially once tax and inflation are taken into account.