Performance Based Fees Fresno County Employees Retirement - - PowerPoint PPT Presentation

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Performance Based Fees

Fresno County Employees’ Retirement Association

December 3, 2008

Jeffrey MacLean S enior Consult ant

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Performance Based Fees

Background

• Active managers exist to provide incremental return over a passive

benchmark which can be purchased by a fund sponsor for less than 5 basis points depending upon the size of the mandate.

• Active managers emphasize their historical record of beating a benchmark

throughout the sales and marketing process.

• Active managers enj oy significant margins in delivering their services to

fund sponsors. They also have low marginal costs associated with adding a new client.

• S

tatistics indicated that few managers have been able to consistently add value relative to a passive benchmark.

• Given these facts, fund sponsors started to implement Performance Based

fees that reward excess returns.

• FCERA currently only employs a Performance Based Fees with Brandywine.

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Normal Fee

Performance Based Fee Example

• Assets: $100 million
• Manager A Normal Fee S

chedule: First $100 million: 70 basis points Next $100 million: 60 basis points

• Base Fee (BF): 20 basis points
• Required Excess Return (RER): 150 basis points

Performance Based Fee:

• If Manager A has underperformed the benchmark, Manager A only earns

their base fee of $200,000, as opposed to earning their normal fee of $700,000.

• If Manager A has outperformed the benchmark, Manager A will earn that

base fee plus the performance fee. Calculation shown below: Performance Fee = [(NF-BF)/ RER] x (Portfolio Return-Benchamrk Return-BF)

For illustrative purposes only

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Performance Based Fee

Worksheet

For illustrative purposes only

Manager: Manager A Client: Fresno County ERA Performance Fee Componets: Mandate: $100,000,000 PF = [(NF-BF)/RER] x (PR-BR-BF), where: PF = Performance Fee Fee Schedule: NF = Normal Fee (refer to Normal Fee schedule) First $100,000,000 0.700% BF = Base Fee Thereafter >$100,000,000 0.600% RER = Required Excess Return PR = Portfolio Return BR = Benchmark Return Annual Fee: First $700,000 0.700% Minimum Fee = Base Fee (BF) 0.20% Thereafter $0 0.000% Maximum Fee = [(2 x NF) - BF] 1.20% Total $700,000 0.700% NF = 0.70% BF = 0.20% RER = 1.50% Benchmark = R1000 Growth Performance Scenarios (PR-BR-BF) $ % $ % $ % 0.00% $200,000 0.20% $0 0.00% $200,000 0.20% 0.25% $200,000 0.20% $83,333 0.08% $283,333 0.28% 0.50% $200,000 0.20% $166,667 0.17% $366,667 0.37% 0.75% $200,000 0.20% $250,000 0.25% $450,000 0.45% 1.00% $200,000 0.20% $333,333 0.33% $533,333 0.53% 1.25% $200,000 0.20% $416,667 0.42% $616,667 0.62% 1.50% $200,000 0.20% $500,000 0.50% $700,000 0.70% 1.75% $200,000 0.20% $583,333 0.58% $783,333 0.78% 2.00% $200,000 0.20% $666,667 0.67% $866,667 0.87% 2.25% $200,000 0.20% $750,000 0.75% $950,000 0.95% 2.50% $200,000 0.20% $833,333 0.83% $1,033,333 1.03% 2.75% $200,000 0.20% $916,667 0.92% $1,116,667 1.12% 3.00% $200,000 0.20% $1,000,000 1.00% $1,200,000 1.20% Annual Performance Fee Annual Base Fee Total Fee

Performance Based Fee Worksheet

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Performance Based Fee

Pro/Cons

Pros:

• Aligns the interests of the

manager and the fund sponsor.

• Matches the fee cash flow to the

economic well-being of the portfolio.

• May be a good way to reduce fees

paid to a manager and escape “most favored nation” clauses. Cons:

• Manager may “game” the portfolio

to add beta into the portfolio to achieve a higher fee or subtract beta to hold onto the Performance Based fees already earned.

• Can be complex to administer.
• Some managers argue that it is

inappropriate to create an Performance Based that may treat clients differently.

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• Normal Fee: This is the managers normal active fee that the quote during the sales and

marketing process. It usually has fee breakpoints at different asset levels, rewarding larger mandates with a lower average fee.

• Base Fee: Fee manager is paid regardless of the performance obtained. These fee is usually

more than what a fund sponsor would have to pay an index manager but substantially less than the normal fee.

• Benchmark Return: Return of the agreed upon benchmark (i.e. Russell 3000 Value Index)
• Required Excess Return: This is the required excess return that the manager must achieve to

earn the Normal Fee.

• Portfolio Return: Gross of fee actual portfolio return.
• Average Market Value: Average of the beginning and ending market value of each quarter for

the base fee. The average of the quarter-end market values comprising the period over which the performance fee is calculated.

• Performance Fee: [(Normal Fee – Base Fee)/ (Required Excess Return)] x (Portfolio Return –

Benchmark Return – Base Fee)

• Total Fee: [Performance x Average Market Value] + Base Fee
• Minimum Fee: The minimum fee is the base fee.
• Maximum Fee: [(2 x Normal Fee) – Base Fee]
• Phase in Provisions: One year for the first year, since inception basis for the first five years,

and then rolling five years thereafter.

Performance Based Fee

Components