Probing performance fees
I enjoyed reading your April 28, page 26 article on performance fees. As a company with 70% reliance on performance-based fees, this is a subject with which we are reasonably familiar. Some interesting observations:
Are performance fees also an incentive? With a reputable manager, they shouldn't be. Managers should never favor one client over another.
Does a willingness to accept performance-based fees serve as a strong indication of a manager's confidence in their own process? You bet.
Do they align client interests with manager interests? Absolutely.
Do performance-based fees save money? Unclear. If managers in aggregate perform at or below benchmarks, they typically will save money. If managers in aggregate (or even a couple of stellar outliers) perform well ahead of a benchmark, overall fees may increase, not decrease. It depends on results.
Are clients sometimes annoyed when the performance fees pay off? Surprisingly, yes. A client should be hoping for the best possible performance, hence ironically should root for the largest possible fees. Yet, surprisingly, we occasionally find a client who is annoyed when this strategy works and the performance-based fee is substantially larger than our asset-based fee schedules.
Are performance-based fees more work to administer? You bet.
Do performance-based fees affect the management of the investment management firm? Absolutely, on two counts. First, revenues become highly volatile, reducing a firm's reliable core profitability; here at First Quadrant, our base revenues are only 0.16% of our actively managed asset base. Secondly, in a performance downturn, the manager faces a risk that the revenues disappear long before the assets leave; this means that revenues can fall long before the book of business (hence, the necessary expense base) shrinks.
Should clients move in the direction of performance-based fees? That depends on a host of issues: What will be the board's reaction to large fees when strategies pay off? Has the investment group typically been successful in identifying superior managers, hence likely incurring increased costs by moving to performance-based fees? And, does the reconciliation of such fees increase the administrative burden on an already lean investment staff?
A few other subtleties are rather interesting.
In a sense, performance-based fees are a "bet" on the sponsor's part that they do not have skill in selecting superior investment managers. If the sponsor is good at choosing active managers, they will pay more with performance-based fees than with asset-backed fees.
In short, this is an intriguing area that we think will grow, not diminish, in the years ahead.
Robert D. Arnott
President and chief executive officer
Sponsor stock in 401 (k)s
Your April 28 editorial "Boxing in 401(k)s" highlights the dilemmas which arise when employer stock is used in savings plans.
For participants, there is the potential to become the next Wal-Mart millionaire, but also the risks posed by heavy exposure to a single security.
For plan sponsors, there are the advantages of using stock (instead of cash) to provide a valuable benefit and to motivate employees, but also the desire to see that stock remain in friendly hands.
Luckily, government intervention is not necessary. Market-based solutions exist which can satisfy the requirement of plan sponsors while protecting participants.
Guaranteed Products Marketing
Metropolitan Life Insurance Co.
Seidle vs. Putnam
Your publication came across looking like it was "used" by Mr. Edward Seidle when you reported the administrative error made by Putnam Investments on your front page May 12.
Looks to me like Mr. Seidle's goal was to embarrass Putnam, and you fell for it. Or will you be soliciting reports of administrative errors made by other plan administrators as well?
Please stick to substantive matters and spare us the isolated personal beefs of ex-employees.
Keep Social Security as is
Once again you beat the drums for a privatized Social Security system in the May 26 editorial.
You again align yourself with the same coalition of the Wall Street industry and the right-wing that has been trying to destroy the Social Security system since before its inception in the 1930s.
They are livid that the system has been the most successful social program in the country, and that they can not shake the solid support for the Social Security program by the vast majority of Americans of all political persuasions and income groups.
The Cato Institute for its ideologic reasons and the Investment Company Institute, State Street Bank and Merrill Lynch and others for their selfish, greedy reasons are attempting to change the defined benefit Social Security benefits for retirement, survivor benefits and disability benefits into still another defined contribution saving plan.
This plan promises working Americans nothing and piles the risk of providing for their economic future on an individual account rather than on a broad program that all Americans contribute to and all Americans benefit from.
How much in fees would the Wall Street industry stand to make on a reserve fund of $560 billion that will grow by more than $70 billion in 1997 alone?
How much more money would working Americans lose in inappropriate investments pushed by avaricious and dishonest investment companies, as reported in your newspaper?
How many records of accounts would be fouled up by investment companies, as recently reported in your newspaper?
No, the current rather modest financial problems facing Social Security should not be used as an excuse to provide further financial windfalls to the Wall Street industry, but should be used as reason to burnish the most effective anti-poverty program in the history of the country.
We must continue to supply financial security to retired Americans, disabled Americans and the survivors of deceased Americans by means of a broad-based program that is an earned right, equitable and maintains adequate benefit levels.
United Federation of Teachers