New Funds Take Pay Cut If They Can’t Beat the Market
Money managers are offering new fulcrum funds where pay is based on performance
A wave of stock-picking firms are stepping up their fight against cheap exchange-traded and index funds with new offerings that dial back fees if they can’t beat the market.
AllianceBernstein Holding AB -0.25% LP, Allianz Global Investors and a handful of other managers have debuted new funds in the past year featuring fees that rise with returns—and tumble to ETF levels when they fall short of their benchmarks.
While so-called fulcrum funds have been around for years, the new ones have other characteristics. For one, they start with a lower base fee that can rise and fall more sharply, depending on performance. Second, the fee structure is a central selling point of the fund itself.
The managers say the new fee structure more closely aligns their interests with those of their clients, and caters to cost-conscious investors who still crave funds that don’t track indexes. The concept, and other new tactics, also offer hope for the industry’s future; even some of the most ardent supporters of active managers have struggled to justify paying higher fees for funds that can’t beat the market.
It is hard to tell if this new flavor of fulcrum funds will succeed in winning back skeptical investors. Would-be clients say their structures are more complicated than meets the eye.
Some of the new funds, including AllianceBernstein’s offerings, reset to their starting-point fees after one year no matter how they’ve performed. And there is no high-water mark, which is a return hurdle many hedge funds must clear before they can start charging clients performance fees again after they’ve underperformed for a stretch.
These features might even tempt managers to take too many chances once they slip below their benchmarks, in a bid to chase higher returns—and higher fees.
“What are the unintended consequences?” asks David Bailin, global head of investments at Citigroup Inc.’s private bank. “Does the manager take on more risk seeking higher fees? You wouldn’t want the manager to have a different incentive than investors.”
Allianz executives said they sought to address this concern by basing their fulcrum funds’ fees on a rolling, 12-month period. Hedge funds may have a high-water mark, but they also won’t slash fees below their base cost when they underperform, they argue.
For decades, asset managers occupied one of the cushiest enclaves on Wall Street. Managing other people’s money produced thick profit margins and came with few balance-sheet risks. That world is now under siege. Trillions of dollars have left stock- and bond-picking firms in the past decade, as investors have become more drawn to less-expensive and often better-performing ETFs and index funds.
As managers came to accept that the passive-investing wave was here to say, many initially turned toward businesses under less pressure from index funds and ETFs, like emerging-market stocks or privately held debt.
The new fulcrum funds are a bid to take on passive funds on their own turf: price competition. In addition to industry leaders, former AllianceBernstein Chief Executive Peter Kraus’s recently launched management firm will also have a fulcrum-fee structure.
Financial advisers, the gatekeepers to individual investors, say they like the concept—even if they don’t know quite what to make of the new funds yet.
“Creativity is necessary now,” said Brian Johnson, chief investment officer of Viridian Advisors, a $500 million wealth-management firm. “The low-cost options aren’t going away, and the math isn’t in favor of the active managers. It is good that change is afoot, but you need to be convinced that the fee deal is meaningful enough.”
While Mr. Johnson and other wealth advisers are intrigued, they say understanding how and when fees change, and then explaining those nuances to clients, takes time.
AllianceBernstein’s AB FlexFee Large Cap Growth Advisor Fund, the largest of the firm’s six fulcrum funds, has drawn $106 million in assets since its June 2017 launch. Fred Alger Management Inc.’s Alger 25 Fund, launched in December, now manages $11.4 million. Allianz’s Structured U.S. Equity Fund, which started that same month, has $78 million.
By comparison, Fidelity’s new zero-fee stock-market index fund has lured more than $1 billion since its Aug. 2 launch.
Persuading advisers and their clients will take time, said Chris Thompson, head of the Americas client group for AllianceBernstein. Mr. Thompson said that 10 large wealth-management firms had already added at least one AllianceBernstein FlexFee fund to their platforms.
“The big impact of this will be if we can take money from passive, or money that would’ve gone there,” said Mr. Thompson. “That’s the ultimate goal here.”
That goal isn’t lost on anyone in the industry.
A number of active managers are exploring the concept, industry executives said. Even BlackRock Inc., the biggest passive manager, is studying adding a performance-fee dial to ETFs, a person familiar with the firm’s plans said.
Mr. Bailin, whose private bank serves wealthy individual investors, said fulcrum funds aren’t an antidote for what ails active managers.
A variable fee, no matter how low it goes, is no substitute for good performance.
“We pay the manager all the fees we need to, and if they outperform, I’m thrilled,” Mr. Bailin said. “If the fund underperforms, I’m not thrilled.”