A better structure for performance fees

I'm writing in regard to Russell Kamp's July 9 article on performance-based fees. I'm glad to see this being discussed again. Performance-based fees are a good idea if the structure is fair and accurate. The last time we tried performance fees they failed because the deals were too one-sided, favoring investment managers. If sponsors want a fair deal, the following terms should be required:

The benchmark must be correct. The S&P 500 was the benchmark for everyone in the last go-around. This was a mistake.

Compensation should be tied to the significance of success, rather than some arbitrary thresholds, like two percentage points above the S&P 500 return. Importantly, peer group rankings should definitely not be used because they are loaded with biases.

Gaming the deal should expose the investment manager to a serious penalty. For example, investment managers should think twice about making big bets away from the benchmark.

Settlement should be annual with a high-water mark if the benchmark is not exceeded.

Sponsors should write the contract accordingly.

How does that strike you?

Ronald Surz

President, PPCA Inc.

San Clemente, Calif.

Editor's note: Mr. Surz is also president of Target Date Solutions, PPCA's wholly owned subsidiary, also based in San Clemente.

This article originally appeared in the September 3, 2012 print issue as, "A better structure for performance fees".