Can a performance fee model help advisors, investors in current volatility?

CI GAM looks to be putting their money where their mouths are. The asset manager announced last week that they were launching a new “Performance Series.” The series, which will be applied to seven existing Private Pools, will not charge a management fee. They will instead charge a performance fee that will only be paid when an investment pool outperforms its reference benchmark. Marc-André Lewis, President and Chief Investment Officer at CI GAM, says he is confident that his funds will be able to outperform their benchmarks and earn their fees.

Lewis explained why his firm launched this series now and how they selected the funds that would have this performance fee applied. He discussed the launch of this series in the context both of a volatile market environment and his conviction that these funds can outperform their benchmarks. He explained that these funds’ goal of alpha generation suit a moment of high market concentration. 

“If you look at what has happened over the last few years, markets have become more and more concentrated, especially in US equities,” Lewis says. “Diversification has not been rewarded, and it has been very difficult for active managers to beat those indices. But I think we’re at a spot where active management has started to deliver. Over the past year or so, there has been outperformance by active managers as we get de-concentration in the markets. That is the window where we’re confident we can outperform and therefore we’re willing to waive fees if we don’t.”

Lewis highlights the fact that this fee model is not being applied to brand new funds. Rather, they’re applying it as a series to existing strategies with established track records. That established nature, he notes, gave him further confidence in the ability to outperform.

While most of the strategies included in this series hold equities and would therefore be more expected to play the alpha generation role, the new series includes one fixed income fund. Lewis accepts that fixed income would traditionally play more of a defensive role and that alpha generation is often not what investors want or even expect from their fixed income. He notes, though, that this fund is a high yield credit strategy, which tends to have more equity-like performance and greater potential of achieving that performance goal.  

From an end-user standpoint, Laurel Marie Hickey notes that fees are more often an issue for advisors and clients in down years. The Senior Wealth Advisor & Senior Portfolio Manager at Wellington-Altus Private Wealth notes that when markets underperform and portfolios pull back, paying a management fee feels much more onerous than when returns are strong. Anything that helps offset a downturn, she adds, can be an area where clients see real value.

“Portfolio managers ca really shine in a down year,” Hickey says. “One of the biggest things we get from clients on a down day is when they tell us they weren’t as down as they expected to be and thank us for getting them there.”

Hickey operates a quantitative model of 22-33 names, and so typically only uses an externally managed fund in a buffer position. She notes that there could be some appeal in using a possible performance fee model on fixed income assets, simply because the returns on fixed income funds tend to be that much lower. Speaking hypothetically about a performance fee model, Hickey says she might consider using them as a means of accessing momentum in the markets, with the fee waiver functioning to offset potential downside should it occur.

For Lewis, the new fee model also offers an avenue for advisors and their clients to transition away from passive investing. Many investors, he notes, prefer passive management because of the low fees that come with them. Offering active strategies with a performance fee, he argues, can change that conversation, especially in a period of market rotation.

While the fee structure in these funds makes them novel and may help to soften the blow of a downturn, Lewis says not to expect a different fee structure to drive returns. This structure can help investors, advisors, and fund managers feel more aligned in their incentives but investing in them with the expectation that they’ll cost less may be the wrong approach.

“Our hope is that advisors and investors expect they aren’t going to get this fund for free,” Lewis says. “I would separate the two. The fixed fee versions of all these funds have delivered very strong and compelling returns net of fees. These are still products that should be judged on the merits of their investment strategy.”