Both fund managers and investors should share the risk of funds underperforming, some leading UK academics have claimed.
The current typical structure of funds, where fixed fees are charged to investors regardless of returns, was “skewed in the interest of fund managers”, according to researchers at City University’s Cass Business School.
In a report entitled ‘Heads we win, tails you lose’, billed as the most detailed study of its kind, the academics said a sweeping review of the charges levied by UK funds was required.
It argues for fund managers to be paid exclusively through performance fees, where they might, for example, receive a certain percentage of outperformance of their benchmark index.
The report describes this as a ‘symmetrical’ fee structure where investors and fund managers both share the pain if a fund is failing to deliver. This is opposed to an ‘asymmetrical’ structure in which funds carry both performance and fixed annual fees, or a purely ‘fixed fee’ structure.
The report heaps even more pressure on asset managers, which earlier this month were broadsided by the Financial Services Consumer Panel – the body that advises the regulator on consumer protection – which also called for radical changes to fee structures.
It comes on top of extensive changes to the way fund fees are structured that took place when the RDR was implemented in 2013, banning fund houses from paying commission to other parties in the distribution chain.
“The most widespread fee structure is the least appropriate from the perspective of investor welfare, creating an ‘incentive mismatch’,” the report stated.
The study’s findings are based on academic simulations of thousands of fund managers with varying skills, carried out by professors Andrew Clare, Richard Payne, Nick Motson and Steve Thomas.
The co-authors looked at the average ‘financial well-being’ of both the investor and fund manager under the three fee structures in a number of market scenarios.
“Our results show that the most prevalent fee structure currently in the UK market (a fixed fee as a proportion of [assets under management]) is generally the best structure for the manager and the worst for the investor,” said Mr Payne.
The Cass Business School has become an increasingly high-profile source of criticism of investment industry practices of late.
In a paper published in June, Cass professor David Blake rubbished the idea that investors could reliably identify ‘star’ fund managers. He said 99 per cent of equity fund managers simply failed to deliver outperformance from stock selection or market timing.
In May, Cass’s Pensions Institute unit published a major report claiming asset managers were failing to reveal all of their fees, based on a project that assessed the body of academic research on fund-charging practices.
The latest report adds the findings were ‘stress-tested’ by the academics through a number of scenarios, but “none of these model variations changed the base results and our main conclusion”, said Mr Motson.
“The results in this paper give rise to a natural question: since investors would prefer symmetric, performance-based charges, why don’t more fund managers offer such fees?”
