Paying the same fee regardless of whether a fund performs well or poorly is “outmoded”, Ptak said in a recent post online, and is one of the reasons investors are fleeing to passive funds.
He has urged managers to vary charges according to whether the fund beats or misses its benchmark and to put some skin in the game rather than depend on the “gravy train” world of fixed fees.
“Investors are heading in droves to passive funds in large part because they want a fairer shake — that is, to pay fees commensurate with the value they feel they’re receiving. By this standard, active funds aren’t cutting it. And why? Because they charge a premium for a value-add that often fails to materialise,” he said.
Among the benefits of transferring to performance-based charging, Ptak said, is encouraging more patience and conviction in managers who trade too often and less index-hugging or ‘closet trackers’.
Being paid based on performance would also prevent managers allowing funds to grow to an unsustainable size but could ultimately result in more fund closures.
Ptak said: “In other words, it raises the bar, and many active funds, and fund companies for that matter, won’t be able to clear it. That might not be such a terrible thing.
“There are still far too many marginal active funds. A smaller pool of higher-quality funds is better for investors and, therefore, the industry itself over the long term.”
He added that performance-based fees are “no silver bullet” and will not save active funds from themselves but a shift could be made and should be applauded.
“Investors need reassurance, proof really, that active managers are in this together with them. Further, active managers need a mechanism that further encourages them to go their own way, veering from the benchmark and holding the line on trading.
“Thus, while performance-based fees aren’t going to completely arrest the trend toward lower-cost investments or fully dispel doubts about the value of active investing, we should encourage — even applaud — attempts to innovate.”