Fee guidance doesn't answer all questions
Fund managers have been given more information about the fees they are required to disclose to investors - but some still have concerns.
Monday, May 30th 2016, 6:00AM 
7 Comments
by Susan Edmunds
Fund managers have to offer investors fee information in their funds' product disclosure statements and in their ongoing quarterly fund updates.
Fees that must be disclosed include management and administration charges, performance fees and the fees of any underlying funds the fund manager invests in. If they cannot get an accurate representation of the underlying funds' fees, they need to be able to explain why not.
This is designed to give investors a clear view of the total fees involved with the fund structure.
But the Financial Markets Authority said the definition of an underlying fund was broad.
"It is broader than just funds that are investment options in licensed managed investment schemes."
That has prompted questions from some managers, who were otherwise generally supportive of a move to more fee transparency and standardisation of reporting.
Devon said listed property companies could be an issue because they did not usually publish an expense ratio.
Salt asked about infrastructure companies and NZAM raised the question of underlying hedge funds.
John Berry, of Pathfinder Asset Management, said he was interested in how funds investing in listed private equity or venture capital vehicles would be treated.
"I am a director of Punakaiki Fund Limited which we plan to list at some stage in the future. There are other private equity managers thinking along similar lines. Private equity vehicles are actively involved in their investments and generally charge a 2% management fee. If a growth or balanced KiwiSaver fund was to invest in a listed private equity vehicle, would the KiwiSaver be required to include the 2% management fee as part of their fee disclosure? This remains an open question."
He said, as a matter of policy, New Zealand should be encouraging KiwiSaver funds to invest in private equity vehicles via listed entities.
"Including the 2% fee in the management charge would potentially kill this because the push is for KiwiSaver to demonstrate lower and lower fees. Three key objectives for long term investing via KiwiSaver are not all compatible - consistently lowering fees, disclosing every fee or charge in every underlying investment and giving investors access to alternative, potentially high performing, long-term growth investments like private equity. Only two of these three can ever be achieved.
"The guidance note leaves a grey area. Does the KiwiSaver fund invest in a listed private equity entity to have the benefit of the changes in share price of the entity, or to get access to the underlying investments of the entity? In the former case the management fee does not flow through, in the latter it does."
He said it seemed that the FMA was leaving the possibility of some listed private equity entities not to be treated as underlying funds. "From a policy perspective I would support this outcome."
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Every stock you own represents a slice of a company that pays multiple CxO's to manage the company's assets. They CxO group directly controls the asset book (asset allocation) of the company, purchases and sells assets, with the fortunes of the company's investors reliant on their skill and industry. And yet, this level of "management fee" is traditionally ignored when considering the management fee of portfolios.
Are we focussing on investment vehicle management fee, simply because we are more comfortable applying the principle of management fees to those vehicles?
Is it a bias towards the more easily measurable information? If "management fees" for companies were common place, why wouldn't we include them?
Why, in this context, are the efforts of portfolio managers buying a share of a company treated differently to the efforts of CxO's who might do the same?
Obviously the type behaviour we all find abhorrent, is when a guardian of investor's treasure outsources the bulk of their investment selection to external managers, but then sets their fee as if they were doing all that work themselves. All while obscuring from investors sight the investors assets distributed to those underlying managers. Essentially, charging for asset allocation and security selection when only doing the former.
It seems like this particular behaviour (or the more egregious examples of it) is one very good reason to require total fee aggregation using as much information as we anyone can reasonably assemble.
The FMA’s work is a big step in the right direction to achieve this.
The FMA guidance note recognises that there is a grey area on what disclosure should be required where a managed fund invests in some listed entities. Just to be clear, we are not talking about ETFs (I agree a fund investing in an ETF should include the embedded ETF management fee in its fund expenses). But, as you note, listed investment vehicles (particularly where the underlying assets are unlisted) are very different to ETFs.
My particular focus is investment by KiwiSaver funds. Here’s my thinking on why the management fee of a listed private equity entity should not be included in the expense ratio of a KiwiSaver fund that invests in it:
1 – Firstly, I’d argue for consistency. Do you expect KiwiSaver funds that invest in infrastructure or investment companies like Infratil to add the running costs of Infratil to the KiwiSaver fund fee? Surely not? (Infratil is essentially an externally managed closed ended fund). How is a private equity entity different to a listed infrastructure fund?
2 – Secondly, KiwiSaver investors (particularly investors with a long investment horizon and high risk appetite) should have access to the private equity asset class. KiwiSaver managers (with the notable exception of Milford) are not in favour of this arguing
(1) PE is not liquid,
(2) unlisted PE has high compliance costs for the KiwiSaver manager and
(3) PE fees will impact the headline KiwiSaver fees disclosed.
A listed PE entity answers (1) and (2) – but the fee disclosure remains a key reason why KiwiSaver will continue to avoid PE, even in a listed entity. We need a policy response that is sensible and also encourages the right investment outcome for KiwiSaver investors.
PE investing has worked very well for sophisticated NZ investors like NZ Super and ACC – I’d argue KiwiSaver investors should also have access to this asset class.
Thanks for your thoughts.
1. Yes I do. We calculate Infratil’s MER when we report to clients just like we do for all other closed end funds and I agree a private equity fund is no different.
2. It is not critical that KiwiSaver investors have access to the private equity asset class especially given that many institutional funds overseas seem to have had enough of the high fees and poor performance according to the FT.
Last but not least private equity may have worked well for NZ Super and ACC – I don’t know – I haven’t seen the stats. But even if it has the problem is Mum and Dad don’t get access to the funds that NZ Super does let alone the same sort of fee deal. As some smart fellow said in the FT a while ago “I wouldn’t invest in any hedge fund I was able to get shares in”. The same applies to venture capital.
Your second point is interesting. A number of "sophisticated" PE investors in NZ have expressed the view to me that they don't want retail / KiwiSaver money flowing into PE - the reason they are making good returns is that there are plenty of opportunities and a restricted supply of capital. A significant increase in available capital would likely (at some point) see very competitive bidding and pressure on returns. I'm not sure that is a reason to not find a route for KiwiSaver to have PE as an asset class option.
MPT Heretic, my business partner (Paul Brownsey) has already beaten me up over the point you raise. He equates my argument to absolute return managers who argue "don't worry about the size of our fees, it's only the after fee return that matters." You and Paul make a fair point. Unfortunately large KiwiSaver providers will not move into PE any time soon. The liquidity, fee, valuation and compliance issues first need to be solved for.... and there is no simple solution.
To the extent industry sees this as a problem worth solving, it is interesting to note that an internally managed listed PE entity (i.e. a value add business rather than an asset holding company) may be regarded differently under the FMA guidance.
Yes we do calculate and disclose the MER for listed property trusts. We have done that since we started business, not because we are compelled to do so by the FMA or any stupid Code of Ethics.
When we disclose the total annual fees implicit in a recommendation we calculate the weighted average MER of the funds recommended in the portfolio.
I don’t see how advisors could discharge their responsibility to disclose the cost of a recommendation by doing otherwise but I guess if you have a team of compliance experts you could probably get around it somehow!
We took the view that it is cheaper to disclose everything properly rather than spend millions on a compliance department.
Regards
Brent
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For the record I have owned shares in a listed private equity fund for 25 years and the high fee structure is the reason it trades at a discount. Here’s a prediction - when and if Punakaiki lists it will go to a discount eventually as well unless the firm employs a buyback strategy like other listed closed end funds do locally to support their share price.