Posted by on Jan 14, 2017 in Articles & Advice, Blog, Featured, Posts |

By Jason Zweig | Jan. 11, 2017 10:41 am ET

Image credit: “A dog plays on a seesaw with children in Scotland,” photograph by William Reid (1919), Wikimedia Commons

My column this past weekend looked at “fulcrum fees,” a way mutual funds can charge more when they outperform if (but only if) they charge less when they underperform.

At a time when dirt-cheap index funds and exchange-traded funds are wildly popular, you’d think traditional active funds run by stock pickers would be slashing their fees to compete. There isn’t much sign of that, however.

Annual expenses at U.S. stock funds did inch downward from 0.786% in 2015 to 0.774% in 2016, calculates Jeffrey Ptak, global director of manager research at Morningstar.

But not all that decline, he says, came because funds cut their fees. Rather, funds investing in large stocks grew faster than those that hold mid-sized and small companies — whose higher research costs tend to make them more expensive for fund companies to run.

In fact, more funds’ annual expenses went up than down between 2015 and 2016: Fees stayed the same at 2,853 U.S. stock funds, fell at 1,607 and rose at 2,306, according to Mr. Ptak’s data.

So, as my column suggested, perhaps more fund companies should offer fulcrum fees that go up when performance is good and down when it’s bad.

That would break with the flat fees charged by most mutual funds. It also differs from the “2 and 20” charges that hedge funds often impose, in which the manager takes a 2% fee annually even in losing years, plus 20% of any gains in winning years.

Managers who charge fulcrum fees make “a pretty strong statement about their confidence in their own abilities,” says Andrew Junkin, president of Wilshire Consulting in Broomfield, Colo. “It’s a way for clients to say, ‘Let’s see you put your fees where your mouth is.’”

This doesn’t guarantee that clients will save money on management costs. But paying lower fees in periods of poor performance, Mr. Junkin says, can “decrease the clients’ behavioral bias to give up at the bottom.”

Queens University in Kingston, Ontario, invests a portion of its approximately $1.5 billion pension fund with Orbis Investment Management, a firm described in my column that charges higher fees when it outperforms and lower fees when it lags. Orbis reserves the extra fees in good times and refunds them in bad.

“Most other performance-fee structures are asymmetrical,” says Brian O’Neill, director of investment services at Queens University. “The fund manager has unlimited upside potential and a limited downside. That can encourage risk-taking behavior that isn’t in the clients’ best interests.”

On the other hand, he says, with a fulcrum fee “managers do well when we do well, but they also feel pain when we feel pain.”

College of the Holy Cross in Worcester, Mass., also invests with Orbis. Its fee is “a great way of compensating a manager for long-term performance and good, contrarian thinking,” says Daniel Ricciardi, an investment officer at the college’s $725 million endowment.

Some hedge funds and other private portfolios charge no annual management fee at all but take 25% of any profits above a predetermined rate of return, often 6%.

“I am absolutely certain that introducing the zero management fee has raised the quality of my investor base,” says Guy Spier of Aquamarine Fund in Zurich. “The people who understand the better alignment are more thoughtful and think longer-term.”

In the partnership between investors and the people who manage their money, whatever can reduce conflicts of interest and align both sides in the patient pursuit of long-term profit is a good thing.

Source:, MoneyBeat blog,




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