The pros and cons of refundable investment fees

Amidst all of the talk about transparency in the investment industry, the dialogue around refundable fees has been on the quiet side.

Also known as symmetric fees, they go up when the performance is good and down when it’s bad. Take a manager earning a fixed fee of 0.65 per cent with a symmetric component of plus or minus 0.20 per cent. In the event of outperformance, the manager could earn up to 0.85 per cent. But in the event of a poor showing, that could drop to 0.45 per cent.

“It’s designed to ensure that, over the lifetime of a client’s investment with a manager, any performance fee they have paid that manager is directly commensurate with the actual value they have realized from their investment, not the path of that outperformance,” says Chris Horwood, an investment counsellor at Orbis Investment Management Ltd.

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Queen’s University has invested a portion of its $2-billion pension fund with Orbis using a refundable approach since 2010. Brian O’Neill, the university’s director of investment services, says the fee structure is a good example of aligning investor and manager interests. “Many performance fee structures have an asymmetrical relationship that can incentivize the investment manager to take risk. They may have high watermarks and so on, but generally speaking, they’re going to be collecting a base fee even when they underperform and, when they outperform, they get to collect the performance fee.”

‘All the glory and none of the pain’

The benefits for investors are clear, as the fee structure ensures the investment manager feels the pain of underperformance as much as they do, says Andrew Clare, professor of asset management at the University of London’s Cass Business School.

“At the moment, the underperformance is really just felt by the investor, because most fee bases are just a fixed-fee, assets under management. . . . It doesn’t seem quite right to take all the glory and none of the pain.”

But there are also challenges, such as volatility in the fees paid.

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“That unpredictability can be difficult for investors,” says Horwood. “It’s much easier to budget when you know you’re going to be paying your manager 50 basis points annually and that’s it. When your fee is entirely contingent on performance, on both the up and the downside, that can put some strain on clients.”

Queen’s University’s arrangement is a purely performance-oriented one as it has a zero per cent base fee. “When they outperform, they’re paid very well. When they underperform, they pay us back,” says O’Neill, acknowledging it can be a risky business model for an investment manager. “On the one hand, I’d love to see more investment managers do it but I can see why it can be scary for them.”

Ultimately, Horwood believes that, under a well-designed fee structure, managers should share equally in both good and bad performance. “When you look at fees in isolation, it doesn’t make any sense, unless you can consider the actual value that was created for those fees,” he says.

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And refundable fees represent a bit of variety in the investment industry. “There are hundreds of thousands of funds out there, and the variety of fee structures is close to zero,” says Clare. “We’re not asking every fund manager to offer a symmetric fee on every fund they offer, but it would be sensible for some of the funds . . . to be offered on a symmetric basis, perhaps at a very low fixed fee.”

Jennifer Paterson is the managing editor of Benefits Canada.

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