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Thursday, February 1, 2007
Client guide

Performance fees, paid to asset managers when they outperform a predefined benchmark, are increasingly used in bonus awards. The trend is replacing the traditional fixed fee structures that remunerate on the basis of a flat percentage of assets.

The challenge, says Meyer Coetzee, Head of Product Development at SYmmETRY Multi-manager, is how to calculate these performance fees. “They are meaningless if returns are judged according to inappropriate or flawed benchmarks, or if the structure of the fee scale or the measurement terms are not conducive to fair evaluation.”
He suggests that investors look for five factors when establishing a benchmark for the purpose of setting performance fees. The benchmark should be verifiable, measurable, unambiguous and, of course, appropriate. It should also reflect current investment conditions for proper measurement of the skill a manager employs in managing the portfolio. In South Africa’s less evolved and, therefore, less efficient markets, appropriate benchmarks can be hard to determine.
“For example, it’s not uncommon to find a portfolio with a high level of exposure to equities being benchmarked against consumer inflation. Over the long term this might be appropriate as the risk of short-term market driven distortions are mitigated, or averaged out. Over the short-term, however, it is impossible to distinguish between manager skill and market impact.”
Over the last year, the average equity unit trust returned 38%, while inflation was just 5,4%.
“The rationale behind performance fees is to reward asset managers for the value they add through skilful management. The intention is that they should align manager and investor interests by driving manager behaviour, improving industry skills, and by making products more affordable.
“The hope is that managers will take more active risk and, through skill, enhance returns while, from an affordability perspective, performance fees will align manager remuneration with client returns.”
Mr Coetzee adds that one of the main advantages of performance fees is that they allow skilful managers to earn the same level of fees on smaller pools of assets by generating superior returns. Their alternative would be to gather more and more assets, possibly at the cost of compromised performance.
He says the methodology adopted by SYmmETRY Multi-manager has been to develop appropriate benchmarks and performance criteria that strive to ensure that rewards are a true reflection of the benefits being afforded clients, rather than fortuitous external factors.
Given difficulties in creating proper benchmarks in our market and the inherent peer focus of investors, one solution might be to use a combined assessment. So there could be a fee scale based on performance delivered in excess of a market benchmark, such as the rate of inflation, or a JSE index, for example; combined with some form of peer ranking to determine a more appropriate assessment of excess performance. “This two-tier approach would fuse the concepts of paying for competitive returns relative to an appropriate benchmark and other managers.”
Footnote: SYmmETRY Multi-manager is a member of the Old Mutual Group and has some R20 billion of assets under management. According to independent multi-manager performance tables, the Symmetry Conservative, Balanced and Aggressive Funds are all ranked top in their categories.
In 2001 SYmmETRY was the first South African multi-manager to launch Absolute Return Funds and currently manages almost R7 billion in this category.
For additional information, please visit: www.symmetry.co.za

Copyright © Insurance Times and Investments® Vol:20.1 1st February, 2007
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