Advisers, and clients, don’t mind paying more for active funds. Provided they perform, that is. Active evangelists will pitch it as a simple dichotomy: you pay us more because we make you more.
But what happens when they don’t? What is the mechanism that actually holds managers accountable? They get paid regardless. The fundamental philosophy of active management is under attack right now, and Fidelity’s answer last week was to hit back hard by introducing performance-linked fees across its equity range.
The move is radical. Radical enough that it requires absolute faith in the principles of active management. Fidelity is now completely wedded to the belief that its managers can beat downturns through careful stock selection. It is entirely at the mercy of the idea that even when markets are high, its managers can hit higher. Fidelity is praying at the Church of Active Management, and is begging advisers to join it.
Depending on the detail, the move is either an altruistic appeal to play fair with clients, or a shrewd move to subtly improve margins. There will be a cap on the fees, so clients will not have to hand over their life savings when Fidelity seriously outperforms. But there will also be a floor, so Fidelity won’t be too much out of pocket when the benchmark marches ahead of it.
The thresholds for the cap and floor are absolutely crucial to whether or not this is a good deal for advisers. If the cap is set too high, Fidelity’s managers will have an incentive to keep adding risk to extract as much fees as they can. If it is set too low, then it makes the whole point of the exercise redundant, because the managers will not be rewarded for doing better with investors’ money.
Too wide a range will make cashflow modelling a mess for advisers trying to project what the cost of a client’s portfolio is going to be, when they don’t even know what they are going to be paying for it.
That’s why it is crucial that people really keep an eye on how Fidelity, and those that follow it, operate the new structure. Every single time an active manager is criticised for underperformance, without fail, it will say that the analysis has used the wrong benchmark. Or the wrong time period. Or has calculated costs or total returns incorrectly. As much as this appears to be about accountability, Fidelity could readily move the goalposts and I would wager that a significant minority would be none the wiser.