Performance Fees For The Fund Industry: It's Decision Time

Regulators and investors desire value-for-money

Recent European regulations related to fees are delivering new requirements for the Fund industry. The regulators' ultimate goal is to improve fee transparency and to reach a standardized cost-reporting framework. There's been a lot of debates and discussions on this topic in the past few months, intensifying pressure on fund managers.

As if that wasn't enough, there's also the looming threat of regulators examining active fees for quasi-passive propositions. For example, the Irish financial regulator recently started investigating asset managers after finding irregularities in many funds.

And, investors' growing awareness of the negative impact of fees on long-term investment returns has partially fueled the growth of index funds. This means that fund managers are being compelled to review and fundamentally change their traditional fee models.

Performance based fee models replacing fixed fee models

The main goal of the new fee models is to align asset managers and investor interests by significantly decreasing the fixed based Assets Under Management (AUM) fees while increasing the performance fee model remuneration. In a nutshell, asset managers are only remunerated if they can deliver Alpha, a performance over a certain benchmark. This should help the industry regain investor trust.

Some asset managers have already launched new products based on this model, with mixed results. "Zero-fee Funds" offered by Fidelity in the US is a radical trend to attract young investors who may invest in more lucrative products further down the line. These drastic fee decreases pose a real challenge to asset managers to find new profitable growth sources.

Creation of local performance fee requirements in Germany, Ireland and the UK

Additional local restrictions on performance fees were recently implemented in Germany, Ireland and the UK, piling more pressure on asset managers. They'll need to urgently adapt their fee models if they wish to keep distributing their products in those countries.

The Central Bank of Ireland (CBI) is moving to reinforce its guidelines regarding performance fee structures, requiring UCITS funds to introduce either a permanent High Water Mark (HWM) or clawbacks.

The German regulator BaFin is also putting additional requirements in place relating to performance fees for UCITS funds in Germany including:

a minimum 12-month crystallization period an HWM or a clawback mechanism over at...