In the Netherlands, the continent’s most heavily targeted market place by international money managers, performance related fees have be-come the norm in charging institutional clients for services rendered.
This is unlike some five years ago, when investment managers mainly charged flat fees.
In the not so distant past, the Dutch pensions industry was less than interested in any form of performance fee, recalls Jennie Paterson at Barr Rosenberg European Management (BREM), which has several mandates under management for Dutch pension funds, including the largest fund, Heerlen-based Algemeen Burgerlijk Pensioenfonds (ABP). People used to be reluctant to pay performance fees. The rationale behind this was that fund managers who realise to-wards the end of the year that their performance is lagging, will take big risks in the fourth quarter to try to make up,” she says.
If pension fund managers were led by caution in their decision to steer away from paying their outside managers any performance fees, what is it that makes them demand it now? Part of the answer lies in the increasingly quantitative-oriented strategies followed by fund managers. The increasing use of quantitative techniques used by asset managers for investment decisions is believed to drastically re-duce the risk of a manager taking irresponsible decisions. The systematic quantitative approach simply doesn’t allow investment decisions which do not match the model’s criteria.
The increase in popularity of performance related fees hasalso been brought about by the pressure on pension funds themselves to deliver high returns in order to keep up their payments to an increasing number of pensioners in the near future. A third factor has been the more recent trend of the unbundling of custody and investment fees. Whereas two years ago a pension fund was presented with one bill for both investment management and custodial services, funds now demand an itemised bill or two separate ones.
Stichting Pensioenfonds voor de Metaalnijverheid, the Netherlands’ fourth-largest pension fund employs 27 managers, mainly for specialist mandates, and almost all of them are on performance fees, as well as a flat fee. Some of the managers’ fees are capped, mainly in markets where volatility is high. “Pension funds are burdened with ever increasing pay out levels and there is simply a lot of pressure on us to crank out high investment returns. This is why we as pension fund managers in turn want the most out of our external specialists,” says the fund’s Van den Brink.
The risk of managers taking irresponsible investment decisions in or-der to outperform their benchmarks can also be reduced by screening the managers properly during the beauty parade, adds Van den Brink. Roland Verhoeven, portfolio manager at Stichting Pensioenfonds PGGM, the fund for medical workers in Holland, concurs. “Doing your homework properly in following every manager’s investment approach and making sure that you are absolutely agreed on the investment style before you sign the contract, is your best protection against any risks of this kind.”
PGGM is among the few large funds in the Netherlands that does not employ any managers on the basis of performance related contracts. This, says Verhoeven, is because this meth-od of payment was not in swing when the fund first appointed managers, back in the 1980s. In order to keep the manager contracts uniform, the fund so far has decided not to introduce any performance related fees. “But it is not unlikely that we will not introduce such fees the next time we appoint a manager,” he adds.
What happens when targets are not met and performance is dwindling? Does the manager pay the fund a fee? In some cases, yes. Newton Investment Management is an example of a company which credits clients for un-der performance. Guy Bowles, institutional sales and marketing director, says that if the company does not meet its targets, it will make this up by not charging an outperformance fee when things go better. The company marginalises the negative impact this can have on the company when performance does not materialise, the penalty is calculated over four year rolling periods only and in some cases it is limited to a set maximum. Of all Newton’s clients, 90% are on performance contracts.
Van den Brink says he has similar arrangements with most of his managers. “If the managers under perform, they will first have to make this up before they can charge an outperformance fee again. That is only fair.”
When asked whether fund managers deliver higher returns on portfolios which are paid for on a performance basis than on the mandates on which a flat fee only is charged, all representatives of money managers said no.
Paul Go, director of LGT Asset Management’s Amsterdam office, said that in most cases fund managers are not even aware of the fee structures of the mandates they run. Paterson says her company always charges a base fee covering the actual costs of managing a portfolio. The firm’s performance fee is calculated on a rolling annual basis. Fees are negotiated per case and a charge is agreed with which both the client and the firm itself are happy. Needless to say that the better the performance, usually the higher the fee.
Go confirms this. “Since the introduction of performance related fees, we have been able to charge more, simply because our returns have generally been very good,” he said, add-ing that this way, both clients and LGT have gained. Bowles said that Newton keeps the flat fee artificially high in order to encourage clients to agree to performance fees. The company charges between 10 to15 basis points for a ‘plain vanilla’ equity portfolio. For a balanced mandate, 15 to 20 basis points are levied.
The change in the way asset managers are charging their clients indicates that the pensions industry of the 1990s is slowly turning into a buyer’s market, Metaalnijverheid’s Van den Brink points out. “In contrast to the 1980s, when asset managers determined the contracts and the fees charged, pension funds themselves present their prospective managers with the conditions. Money managers accept this, because there are hundreds of competitors waiting in line to win a mandate.”