CRM2 rules spur pay-for-performance model adoption

New reporting disclosure rules are driving investment firms to experiment with performance-based fee systems

CRM2 rules spur pay-for-performance model adoption

In a few weeks, many investing firms will be sending clients annual reports with two critical pieces of information: how much they paid in actual dollars and how well their portfolios have done over time. While firms technically have until July 14 to comply, most operate on a calendar-year basis and therefore have to inform their clients of the previous year’s performance soon.

With the arrival of such reports, as well as the popularity of low-cost investment vehicles like ETFs and mutual funds, some investment firms have decided to experiment with performance-based fee models, according to the Financial Post.

One such firm is Provisus Wealth Management, which has created a company called Transcend to implement such a model. The fee structure they adopted has clients paying fees similar to traditional ETFs for funds that do not outperform an industry benchmark. But if those funds do, the clients will pay a performance fee equal to 20% of the performance of the fund above the benchmark. “What we’re saying is, here is a money manager that is prepared to put its money where its mouth is,” said Provisus Wealth Management President Chris Ambridge.

Another firm, Toronto-based TriDelta Financial, is offering a “partnership fee” structure option for clients who have at least $500,000 invested: traditional fees will be refunded for returns less than 3%; firms get to keep the fees for delivering returns between 3% and 7%; and an additional partnership fee of between 1% and 3% will be applied, depending on how well the fund outperformed the benchmark. Such a structure will put advisors on the same side of the table as the client, according to the firm’s CEO Ted Rechtshaffen.

While these seem like sweeter deals for clients, Ontario Securities Commission Investor Advisory Panel member Ken Kivenko notes that such structures can encourage riskier behavior. “It’s worth a crack. I wouldn’t buy it myself because I don’t believe any of these guys can beat the market any more. And if they do, it’s only because — with your money — they took high risk. Or they were lucky.”

One way to minimize such risk-taking behavior is to put a cap on performance fees, according to Matthew Manara who directs the private client division at Avenue Investment Management. Since 2003, the firm has been offering clients a discount on fees for 12 months following a loss of even one penny; returns above 10% will correspond to a performance fee of 10% of the excess performance, but it is capped at 1%.

Kivenko recommends that those who invest under such schemes examine the underlying formulas and benchmarks used to measure performance. “Sometimes they use a benchmark, and you can’t find it and you don’t know what it is,” he said. “Or it’s so low it’s not an appropriate benchmark so they beat it.”

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