More Funds Adopt Performance-Based Fees

By Tim Paradis
Associated Press
Sunday, April 8, 2007

Mutual fund investors looking for money-back guarantees on Wall Street have often been told to keep walking.

Investors could grumble but ultimately get little from fund managers. Now, a small number of mutual fund families are using fees to compensate shareholders for lackluster performance and reward fund managers for strong returns.

Fees for eight of Dunham & Associates' 11 funds are tied to performance. So, for example, fees at a fixed-income fund with an expense ratio of 0.3 percent might rise to 0.60 percent if the fund substantially outperformed its benchmark. On the other hand, if it underperformed significantly, the fund would waive the fees.

"When the investors are experiencing euphoria, they don't mind and in fact welcome the opportunity to reward their advisers. When the investors are feeling pain and abused . . . they're annoyed about paying fees for sub-par results," said Jeffrey Dunham, principal at Dunham, whose funds' combined assets are worth about $400 million. "It creates a partnership where one does not exist today."

Dunham conceded that while investors might not save money overall with performance-based fees, they will be relieved to pay lower fees should returns falter. "It isn't about the absolute price," he said. "It's about price relative to value."

Not all funds that aim to assuage customer concerns over lackluster performance regularly reduce fees. Charles Schwab & Co. has 16 managed portfolios, each of which contains several funds. Each portfolio has management fees, as do the underlying funds. While the portfolio management fees can be refunded, the fees tied to the underlying funds aren't refundable, Schwab said.

"We think it's a fair proposition for the clients and we are targeting clients who may not be used to investing in managed portfolios," said Gregory Maged, a vice president at Schwab Investors Services.

Maged said the company isn't worried about shareholders abusing the offer because Schwab would work with them to address their concerns, perhaps by placing them in another fund. Only one customer has requested a refund so far, Maged said.

While Fidelity Investments has since the 1970s adjusted fees on some domestic and international equities funds based on performance, the company's board in February authorized such fee structures for 19 more funds. If approved by the shareholders of those funds, it would give Fidelity 68 funds with performance-based fees.

"We have found it make sense for shareholders because it more closely aligns our economic interests with theirs," said Vincent Loporchio, a Fidelity spokesman.

Fidelity evaluates performance against a benchmark over a rolling 36-month period, to focus on long-term performance. The maximum adjustment to the fees is plus or minus 0.20 percent.

Laura Pavlenko Lutton, mutual fund analyst at investment research firm Morningstar, said she hopes that more funds will adjust fees to mirror performance.

"We're big fans of performance fees because the shareholders get a break when the fund isn't delivering on performance," she said. "We view performance fees as a best practice in the industry."

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