BOSTON —
Fidelity Investments’ plan to subject more of
its adviser-sold mutual funds to performance-fee adjustments got a chilly response last week from some financial advisers who said such incentives could encourage funds to take on too much risk.
Boston-based Fidelity plans to add performance fees to 19 Fidelity Advisor Funds, if shareholders approve. Under the plan, Fidelity would earn higher fees if the funds beat their benchmarks and lower fees if they didn’t.
Fidelity Advisor Dividend Growth (FADAX) and Fidelity Advisor Equity Growth (EPGAX) are among those for which the performance fee is being proposed.
Fidelity’s standard performance fee adjustment range is plus or minus 20 basis points, based on a rolling 36-month performance period.
The move comes as Fidelity is under the gun to boost the relative performance of all its funds. In 2006, just 20% of the company’s funds beat their benchmarks, down from 67% the previous year, according to the privately held company’s so-called annual report, which was released to shareholders last month.
The addition of performance fees is yet another sign that Fidelity is willing to take more risk to improve performance, said Jim Lowell, editor of Fidelity Investor, a monthly newsletter based in Needham, Mass.
“That problem was basically a management-driven — spoken or unspoken — index-hugging policy borne of risk aversion, which turned out to be a very big risk for them and a punishing one, given that their flagship failed to beat its benchmark by hewing to that standard,” he said.
For Fidelity, performance fees are a double-edged sword. For funds that beat their benchmarks, the fees mean millions of dollars in additional fee revenue. For those that miss their mark, however, they mean significant losses.
Consider, for example, Fidelity’s famed $43.8 billion Magellan fund. For the six-month period ended Sept. 30, underperformance cost Fidelity $45.2 million in fee adjustments.
But Fidelity maintains that performance fees are good for shareholders, because they align their interests with its own.
The push to add performance fees to the 19 adviser-sold funds is intended to make the fee structure of those funds more consistent with other funds in its lineup, said company spokeswoman Sophie Launay.
If shareholders approve the company’s plan, the 19 additional funds will bring to 68 the number of Fidelity funds that are subject to performance fee adjustments, she said.
Not everyone is a fan of performance fees, however.
“Our main concern would be that it encourages the adviser to be more aggressive than might otherwise be appropriate,” said Rick Brooks, chairman of the investment committee at Blankinship & Foster LLC, a Solana Beach, Calif., fee-only financial planning firm.
Of the thousands of mutual funds, just 574 classes of shares representing 217 funds have incentive fees, according to Lipper Inc. in New York. Fidelity has the most at 78 share classes totaling $403 billion, or 56% of the total assets of funds with incentive fees.
Such companies as Fidelity and Vanguard are more apt to use performance fees than are publicly traded ones, said Geoff Bobroff, a fund industry consultant based in East Greenwich, R.I. Publicly traded fund companies want to avoid the fluctuations in fee revenue that come with performance adjustments, he said.
Denver-based Janus
Capital Group Inc., whose fund shareholders approved performance fees on 13 funds last year, is an exception.
Large-cap-stock funds with incentive fees beat those without them in the one-, three- and five-year periods ended Jan. 31, according to Lipper. Over the five-year period, funds without incentive fees returned 5.30% on average, while funds with incentive fees returned 5.95%.
Despite the potential for higher returns — and lower fees when a fund lags its benchmark — Mr. Brooks isn’t sold.
“Between the volatility and the more aggressive approach, we have generally thought at Blankinship & Foster that performance fees would not serve our clients,” he said.
The firm, which helps its clients invest about $330 million, doesn’t use Fidelity funds, Mr. Brooks said.
At Cadence Financial Advisors LLC of Dallas, Fidelity funds are used “quite a bit,” said Michael Domingo, who recently helped to found the fee-only financial planning firm after working at Fidelity for more than five years.
Although the addition of a performance fee wouldn’t deter him from a Fidelity fund, given that he likes the way the firm manages money, he isn’t too keen on performance fees in general.
Mr. Domingo said that he doesn’t like mechanisms or investment strategies that encourage people at money management firms to overreach for returns. If a client wants to take on more risk — and is willing to pay performance fees — it makes sense to look at alternatives such as hedge funds, said the adviser, who declined to disclose how much his firm oversees in assets.
The additional performance fees may be a sign that Fidelity is looking to return to its roots of “taking risks and trusting their research and their managers,” Mr. Domingo said,.
Even so, performance fees encourage portfolio managers to take more risk, “particularly when they’re under pressure to perform,” said Ted Bush, a financial adviser at Capital Advantage, a Plano, Texas, financial planning firm that invests $15 million to $20 million for clients.
