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Photo: iStock

Exploring mutual fund fees which are linked to performance

Performance linked fee can be rewarding but it is not a straightforward concept that most investors can understand. Experts share their views

Nilesh Shah, Managing Director, Kotak Asset Management Co. Ltd

Mutual funds should be allowed to link fees with performance. It is a win-win situation for investors and fund houses as performance gets incentivised. However, there should be appropriate checks and balances. To begin with, it should be available to high net worth individuals. Once the concept is well known, it can be introduced for retail investors. It should be transparent—flat fee or performance-linked fee. The terms should be clearly stated.

The linking should be for long-term performance and not short-term performance. The incentive payout should be deferred to ensure that no short cuts are taken to generate performance. The performance should be evaluated on a relative basis, i.e., with respect to appropriate benchmark for a longer term rather than on an absolute basis. There should be a flat fee to cover cost and a performance linked fee. The fund manager should have the ability to leverage to generate outperformance. The time has come to introduce the concept of performance fees.

Jimmy Patel, CEO, Quantum MF

Mutual fund fees should not be based on performance. Such a fee structure may tempt a fund manager to take undue short-term risks. A higher performance fee may mean higher compensation for the fund manager. The fund manager has a share in the upside but if the fund does not do well due to the risks taken, investors have to bear 100% of the downside. When the fund manager leaves, it is the investors who end up with poor returns due to the undue risks that he had taken earlier. The fund manager may also try to deviate from the investment objective of the fund with an aim to achieve high performance fee, which will eventually mean deviating from being true to label. Also, when the market decides to take a plunge, the fund manager would be under pressure to show performance and thus may be seen compromising on the quality of the scheme’s portfolio.

Karthik Jhaveri, founder and director, Transcend Consulting

The current market environment is such that it may appear like the excess returns that the mutual funds generate are shrinking. But ultimately, if you make the return that you are targeting, then perhaps it doesn’t really matter. Fund managers are paid a fee to perform; if they consistently underperform the market benchmark or their peers, ultimately the investors will also see this trend. The demand for such an underperforming fund will fall. Hence, there isn’t really a need to have performance-linked fees as market forces will take over and underperformance will get punished. Performance-linked fee is not an easy concept to grasp. Also, it’s going to be difficult to convince an investor to pay a hefty performance fee when the outperformance against a benchmark is wide. Investors don’t like to pay large amounts of fee for a financial product.

Suresh Sadagopan, founder, Ladder7 Financial advisories

The mutual fund industry has grown manifold in the past two decades but the cost structure is still what it was decades back. The benefits of scale need to work for all stake holders.

However, the cost structure has gone up in the recent past. One of the distortions is the 30 basis points (bps) that schemes can charge for mobilisation from B15 (now B30) cities, which affects all investors.

Another was a 20 bps charge in lieu of exit load, which has since come down to 5 bps. The straight forward way is to remove the distortions as also reduce the costs in a tiered manner, as the schemes assets grow.

Introducing a performance-based charge may inject a desperation to perform, which could increase risks. This in turn may not be a good thing for a typical mutual fund investor.

As it is, the investor is fully bearing the investment risks; adding to that is not a good idea.

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