At Work: Finance and IT - Investment - How to get value from fund managers

Mark Humphreys, a senior investment consultant at Watson Wyatt

Many charities and foundations are obliged to trust a fund manager.

In theory, fund managers are paid according to the value they add. However, the broad reality is an entrenched fee framework that rarely serves charities' best interests.

Nevertheless, because the current lower- return, higher-risk environment offers many alternative ways of investing as well as increasing competition, more questions are being asked of fund managers.

One of the tasks of trustees is to determine whether fund managers offer value for money. Investment managers are the highest cost in a fund; it is important to understand how this has come about and how their fee structures should be changing. Ad valorem fees - fees associated with the size of assets under management, which have been the industry standard for many years - have two big drawbacks.

First, they link fees to markets, giving little indication of the value added or performance: when markets go up, assets go up and so do fees.

Second, when markets fall, the pressures on the investment management business are enormous, effectively weakening their proposition, which is in nobody's interest.

This is why I support a move away from ad valorem fees towards a fixed fee plus a variable performance fee. The fixed fee, which is inflation-linked, covers the fixed costs in the business, making it more sustainable regardless of market activity. The performance fee covers variable expenses such as bonuses (rewarding skill) and profit margin.

There has been a definite trend away from ad valorem fees in the past few years, particularly among our larger clients.

Much has been written recently about the impact of transaction costs on investment returns. In the past, those costs have been regarded as part and parcel of performance. However, some large elements of trading costs have been overlooked and are only now beginning to be properly measured, such as the bid-offer spread, the market impact of the trade and the opportunity cost. The current data is of variable quality. More transparency is required to enable charities and foundations to satisfy themselves that they are getting value for money.

Trustees and their agents need to work harder to understand the motivations, incentives and alignments of interest in the investment industry. Remuneration is a powerful tool, and they must exercise more control over what they spend and where. That will necessitate a rethink of how to act and concerted collective action to bring about change. Fiduciaries need to gain the upper hand if they want good value from the food chain.

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