Wry & Dry

The wrong type of innovation

W&D was interested in PM Turnbull's Innovation Statement, last December.  Not sure about spending $1 billion on it, though.  The PM wants to drive an 'ideas boom'.  Good grief.

Well, W&D has found a worthy and early example of the ideas boom.  But, perhaps it's not quite what the PM had in mind.

Work with W&D on this.

Over the last few years, W&D has seen investment managers offering:

  • Australian share investment funds (nothing wrong with that);
  • a base fee, e.g. 1% (nothing wrong with that);
  • a performance fee, e.g. 20% of the outperformance of a 'hurdle' (nothing wrong with that);
  • but where the performance hurdle is not an Australian shares' index (everything wrong with that).

As a married man, W&D is familiar with performance hurdles.

But in an investment sense, the two most popular performance hurdles in these types of schemes, it seems, are either the cash rate or 0%.  The client is therefore taking equity risk and paying for a cash or absolute return hurdle benchmark.  The fund manager will rake in excessive fees over the longer-term.

Caveat emptor!

The appropriate hurdle for an Australian shares' performance fee is, in W&D's humble view, the All Ordinaries Accumulation index, or ASX 300 Accumulation Index, plus a margin.  

(For example, First Samuel has, for those portfolios on a performance fee, a regime typically of a Base fee of 0.80% and a Performance fee of 40% of the outperformance of the hurdle, where the hurdle is the All Ords Accumulation Index plus 2%.  The Base fee is low, and the Performance fee high, but the hurdle is very high.)

But wait, there's more.

A document has come across W&D's cluttered desk, offering an Australian shares' fund, with a base fee of zero (a nice worm on the hook); a performance fee of 25% (that's okay) but with a hurdle of the 10-year bond rate (unfair).

But wait, there's even more.  The outrageous aspect is that financial advisers will be paid a commission of 50% of the performance fee for 10 years to recommend their clients to the scheme.

Readers will know that W&D considers that commissions are pernicious and was among the first to publicly oppose the payment of commissions in the financial services industry, not least of which was the inherent conflict-of-interests involved.  

But this scheme takes conflict of interest to Olympian heights.  Or should that be, depths.

What is even more outrageous, is that the promoters of this scheme are spruiking not their investment management credentials (which may be most worthy), but the remuneration structure for financial advisers.

This scheme has a unique blend of an unfair fee structure and an extraordinarily conflicted commission payment regime.  It really is most innovative.  

But perhaps not the type of innovation, or ideas boom, in which PM Turnbull wants Australia to lead the world.  

Doubtless the scheme will flourish.  For the very reason that Gordon Geko made famous*.