The last year has seen a steady and encouraging rise of alternative fee structures in mutual funds. In particular, a number of managers have adopted so-called fulcrum structures to their mutual funds. All of these funds charge a low or zero base fee, and then a performance fee for outperformance of their relevant benchmark. The idea is that customers only have to pay up for services that actually outperform benchmarks. Some providers that now offer these funds include AllianceBernstein, Fidelity, Allianz, and Fred Alger. The main criticism of the funds that is that they can skew incentives and push managers to take outsized risk in order to produce upside.
FINSUM: These funds are not without their imperfections, but they are a useful and thoughtful response by mutual fund managers who are realizing they need to do more to justify their raison d’etre versus ETFs. We think they are a good deal for investors because if the results aren’t good, you pay very little, if they are great, you pay for it. Compare that to an ETF, where you are never going to outperform, but will likely pay more than 10 bp.
The so-called “feemageddon” in the asset management industry has been unequivocally good for investors. Fees have dropped across the board, starting with ETFs, but also flowing through to actively managed mutual funds. However, the downward pressure on fees has also created interesting new fee structures. The first one to discuss is the most obvious—free funds. Both Fidelity and Sofi have introduced free index mutual funds and free ETFs, so the line in the sand on fees has been crossed. Other firms, such as Westwood Holdings and AllianceBernstein, have come up with entirely new concepts. AllianceBernstein has a “Flex Fees” actively managed mutual fund which has a low basic fee (ETF-level fee) and then only charges a mark up if it outperforms, offering much better economics to investors. Westwood Holdings, has a little bit different but similar fee arrangement which tries to mitigate the potential for misaligned incentives in “fee only when you outperform” structures, which incentivize portfolio managers to take risks. Their approach is called Sensible Fees, and only rewards incentive compensation to managers based on risk-adjusted performance.
FINSUM: We think the fee disruption going on in the industry is leading to some healthy innovation amongst fund managers. These new funds seem like they will only grow in popularity, especially as fiduciary advisors get more popular.
Well, it has finally happened, but not as anyone expected. The whole industry has been watching for the first zero fee ETF, which just happened with SoFi, but now they are getting the first negative fee ETF. While zero fee index mutual funds debuted last year, ETFs only just got there, until the debut of the SALT Financial Low TruBeta US Market ETF. For every $10,000 invested in the new fund, the issuer will pay you $5. However, as you may have expected, there is a catch. The catch is that once the fund gets over $100m in AUM, its regular fee of 0.29% kicks in.
FINSUM: This is nothing more than a sales gimmick (and they haven’t even structured it well). However, it is indicative of the trend things are heading in.
If there was ever a stat that really represented the big changes underway in the wealth management industry, it is this one: a new survey shows that broker-dealers are earning more revenue from fees than they are commissions. That is a major shift for the group, who until recently existed mostly as commission engines. The stat also reflects the growing trend towards dually-registered B-D/RIAs, allowing advisors to perform both functions.
FINSUM: The regulatory trend and customer trend is moving towards fee-based payment. This stat reflects just how pervasive the model is becoming.
Fund fees are a hot area, and not just in terms of them falling in absolute terms. While everyone is aware of Fidelity’s new zero fee index funds and the price war going on in top line fees, there are also new and interesting fund structures emerging. One kind of new fee model is called a fulcrum structure, where fees are low (ETF-like) unless the funds outperforms its benchmark, in which case the provider gets a performance fee. This kind of structure is more popular with mutual funds and can offer the best of both worlds—low fees for ordinary performance, or outperformance that comes with active management.
FINSUM: We think these kinds of funds offer a better alignment of interest while offering multi-sided benefits. However, the risk is that managers are incentivized to take excess risk in an effort to boost performance over the fulcrum threshold.