Fidelity has released more details of the pricing structure of the new fulcrum-fee share class that it plans to launch in 2018, following October’s announcement. While the group plans to create the new class across all its equity fund range, it is taking a phased approach to implementation, with the launch of the new class for the first batch of funds planned in March 2018 – subject to regulatory approval.
It is important to emphasise that these new share classes require investors to opt in. The first phase includes the following open-ended funds: Special Situations W accumulation shares; European Fund W accumulation shares; Asian Dividend Fund W income shares; Global Special Situations W accumulation shares; and American Fund W accumulation shares.
The new pricing structure will see a 0.1% decrease in the annual management charge (AMC), taking the AMC to 0.65% from 0.75% for the open-ended funds or OEIC, to which a variable fee will be added or subtracted based on the rolling three-year net return relative to a respective benchmark. The group will add/deduct a fee of 0.033% for every percent of relative performance over the three-year period, and will cap the total variable fee applied at plus or minus 0.2%.
If a fund has outperformed its benchmark over three years by 6.1% – 2% a year – it will charge an additional fee of 0.2% – 6.1 x 0.033% – on top of the base AMC. Conversely, if it is has underperformed by 6.1%, it will deduct 0.2% from the base AMC.
How Do the New Fees Compare?
How do the capped fee outcomes compare within the context of their clean-share-class competitors? Using the additional charges – audit, custodian, administration fees etc – applied to the funds, we can estimate each of their overall ongoing fee (OCF) under the new pricing structure and then see where each ranks relative to the OCFs of the clean share classes of their respective peers.
At their cheapest pricing point, when the variable fee applies the maximum reduction of 0.2%, the Asian Dividend fund falls into the cheapest quintile or lowest 20%, with the rest all falling within the second cheapest quintile. In this instance, investors would be paying in the region of 30bps less than the OCF for the existing share class.
At their most expensive pricing point, when the variable fee applies the full additional 0.2%, Special Situations falls within the most expensive quintile, the Asian Dividend Fund is in the middle quintile and the rest fall within the second most expensive quintile.
Given that at this pricing point, all funds would be outperforming their prospective benchmark by at least 2% a year over three years, this does not immediately strike us as unreasonable. In this instance, investors would be paying in the region of 10 bps more than the OCF of the existing share class.
However, it is also important to consider the context of competitor funds and their benchmark-relative performance. Relative outperformance of an index is less meaningful if the average fund within the category is also beating the index. For example, from 1999 to the end of October 2017, the average fund within the UK Flex-Cap category, within which Fidelity Special Situations lies, has outperformed the FTSE All Share index on a rolling three-year basis 78% of the time, with an average annual outperformance of 1.92 percentage points.
In contrast, over the same period, the average fund within the Global Large-Cap Equity Blend category, within which the Fidelity Global Special Situations lies, underperformed the MSCI ACWI on a rolling three-year basis 71% of the time, with an average annual underperformance of 0.61 percentage points. This suggests that there is more scope for outperforming the benchmark in the UK Flex-Cap Equity category than there is within the Global Large-Cap Equity Blend category.
Benchmark Needs to be Harder to Beat
It could be argued that Fidelity benefits from their proposed pricing structure for funds found within categories where it is easier to beat the benchmark, and that investors could find similar levels of benchmark-outperformance through competitors with cheaper fees. In such an instance, we believe that applying a hurdle rate in addition to the benchmark would be appropriate – for example FTSE All Share +1% - in making the product more competitively priced.
With the new pricing structure focusing only on total returns, capital gains with dividends reinvested, it does not account for other aspects of a fund’s objective. For example, Fidelity Moneybuilder Dividend, not one of the first 10 funds to have their pricing changes, is managed with the objective of providing a high dividend yield and growing income stream in addition to capital growth.
With the performance fee looking only at total return, this may become a greater focus than the fund’s other objective. In the same vein, a large cap manager investing in a market where it is hard to outperform the benchmark may be tempted to venture further down the capitalisation scale to increase their ability to outperform and obtain a higher fee. In both instances, the introduction of a performance fee could result in a change in the complexion of the portfolio and of the risk-return profile in a way that investors may not desire. This underlines the importance of ensuring each fund is measured against a relevant benchmark that truly reflects the investment universe.
Fees Add Another Layer of Complexity
While we like the attempt to align the interests of the fund managers with those of investors, there is no conclusive evidence that a performance fee structure is the best way to achieve it. That said, the structure that Fidelity is proposing seems to be reasonable – the measurement period is longer than average, the caps ensure that the fees are not exorbitant at their most expensive, and the idea of not having to pay as much during periods of underperformance may sit well with some investors.
The overall concept of a fulcrum fee should also be easily understood by investors. However, when it comes to the underlying details and actual reporting, there is plenty of scope for confusion. Where the direction of travel in the asset management industry is to simplify the experience of the end investor, it could be argued that a performance fee adds another layer of complexity without proven benefit.
