Where can I find a list of mutual funds with performance fees? I know about BRAGX and I believe that Royce also has/had a fund like this, but I want to know what my other current choices are if any.
The follow article says there are 300 funds that meet this criteria, including 70 Fidelity funds and 27 Vanguard funds, and it links to a list of 100 of them, but the link is now broken and I can't seem to locate any of the aforementioned funds:
http://www.etfguide.com/research/157/16/can-performance
Comments
"performance adjustment" site:fiiscontent.fidelity.com
...not that I necessarily think these funds are superior, but this is often cited as evidence for Bridgeway's above average stewardship even though it doesn't appear to be very unique nor do the majority of Bridgeway's funds even have it (although the range of performance adjustments for BRAGX in particular seem to be 2-3x of other funds).
I started thinking perhaps such an approach was the answer to otherwise seemingly investor-friendly, but high-fee funds, like ARIVX in particular. (See recent threads: MFO April 2013 Commentary is posted, ASTON/River Road Independent Value Fund Update, and I thought the April 2013 MFO was the best Commentary yet - anywhere.)
Other than hedge funds, I did not know a fee structure based on performance was employed or even legal for mutual funds. So, really appreciate you digging into this topic.
Bravo to John Montgomery and Bridgeway Capital Management, Inc. I haven't researched the performance of such funds, but just based on stewardship and investor-first practice, can't help but applaud.
So, more thoughts on ARIVX. Eric Cinnamond believes equities are over-bought. Wanting to protect capital, he opts to move more than half his portfolio to cash, which is yielding 0.1-0.2%. I own ARIVX and pay him to actively manage my capital. But ASTON charges a heavy 1.42 ER for ARIVX, even with large AUM of $718.5M. The fund currently has 58% in cash, which means investors incur a guaranteed loss of $5.3M each year for this portion of their capital. As long as Mr. Cinnamond maintains his bearish position, this allocation is an on-going source of negative alpha, whether he is right or wrong on the equity side.
In fact, I started wondering if it might be better for him use that $5.3M to short small-cap equities, which is effectively what he is doing by holding the capital in cash. Perhaps purchase put options.
But, I suspect the prospectus prevents such moves, not to mention ASTON's ownership. Similarly, the prospectus likely restricts ARIVX from investing in longer-term bonds. So, the fund is boxed-in to a small cap value world, which the manager believes is over-bought. Result: investors end-up paying 1.3% net ER for ARIVX to hold cash. The fund is also closed, exacerbating this investor relations issue. (BTW. Ever wonder what 12b-1 translates to for closed funds?)
A better solution? Performance based fees. ASTON should reduce its ER to basically zero for the cash portion of the portfolio. Reinforce its support of the sub-advisor's decision to hold cash during such times. Seems to me that would be huge show of stewardship. Still not as bold I understand as Bridgeway, but a big step in right direction.
Thanks BannedfromBogleheads for calling attention to performance based fees and Bridgeway. Perhaps there's hope
Around 2004, the company miscalculated the performance based fee, and had to refund money and pay penalties. (SEC action.) To Montgomery's credit (as I recall) he immediately issued a mea culpa, explained in detail what happened, and what he would do to ensure it didn't happen again - taking personal responsibility. Bridgeway wasn't alone - the SEC also went after Dreyfus, Gartmore, Kensington, Numeric Investors, and Putnam the same year. (The linked to article gives a score of performance-based funds as of 2006 - I recognize one as having folded, I think the others are still around.)
BRAGX got its 15 minutes of fame a couple of years ago when its ER dropped to -1/2% due to the performance adjustment.
So performance based ER adjustments may not be all they're cracked up to be. (I really like the idea, but I've not seen much evidence supporting any significant effect they have, and then there are anecdotal incidents like these.)
Here's another factor to consider - you're looking at performance-based ERs - and they're quite rare. But performance-based management fees (how much the human manager is paid based on performance) are quite common. (See, "Portfolio Manager Compensation in the U.S Mutual Fund Industry", June 2012: "about three-quarters of portfolio managers receive explicit performance-based incentives from the investment advisors." (Disclaimer: I haven't yet read this paper.) Is it better that the management company get a performance-based fee (via ER adjustment) or the real human manager? Still thinking about that one, especially given the employer/employee relationship, impact on risk taking, etc.
How does Bridgeway's execution leave something to be desired? Their trade executions are excellent which is why they were commissioned by an outside firm to make their "omni" index funds (though I am not a fan of these nor am I of Buckingham Asset Management who commissioned them).
-Do you mean because they got pummeled in 2008 without ever really rebounding? In my opinion that's the risk that deters others from bidding away the normally outsized returns of their strategies...but I'm not buying past performance I'm buying future performance which has thus far profited me handsomely.
-Do you mean because their funds are extremely volatile for the level of performance (ie low sharp ratio)? Sharpe ratio is meaningless because without access to leverage (such as in an IRA) sharpe ratios can't be converted into more money and for those who simply cannot accept -X% drawdown for emotional reasons I say never sell at -X% and, bingo, you don't have to worry about -X% drawdown (not like a margin call which cannot be eliminated without reducing volatility). Besides, part of the reason I hold these funds is to diversify other holdings and the more volatile they are the more ying they provide to my yang.
As far as the SEC action, my understanding is that Bridgeway correctly calculated their performance fees exactly as detailed in the prospectus, but since the formula specified in the prospectus did not align with SEC rules it was illegal. I don't believe the SEC or Montgomery ever said it was a "miscalculation", but only that it was an illegal calculation because the SEC rules for performance based fees are very limiting.
Finally, I don't think performance based fees are needed to incentivize human managers because that's already accomplished by fixed percentage fees (which rise in dollar amount when AUM rises due to either outperformance or endorsement from new investors). What is needed are incentives to benefit existing shareholders (such as by limiting AUM among other things) and to encourage management to target investment patterns above and beyond the index and although performance based fees are no silver bullet they are one sign to look for in finding funds that do this, IMO.
P.S. And, for me, Bridgeway's charitable efforts are much more my style than mere donations. They encourage and congratulate their employees efforts to exhibit good-will towards mankind in their personal interactions and, if I had to guess, this is the only reason Montgomery still hasn't retired...because Bridgeway provides a way to finance his charitable visions whereas retirement is inherently selfish. Since my goals are similar, I'd rather lose my shirt at Bridgeway than hit the jackpot somewhere else just to donate my winnings to some lazy non-profit who cares more about job security then actually benefitting their nominal cause. So, to me, investing at Bridgeway is like investing in one of those "socially responsible" funds except it's much more profitable and also much more effective because, IMO, doing socially responsible things with profits is more effective then simply bidding up the shares of socially responsible companies.
Bridgeway funds' objective is to make money. To the extent that they fall short they fail to execute on their objective. The larger cap funds have done okay, but some small caps - which were supposed to be Brideway's bread and butter - have not.
Bridgeway broke the rules, and your comment is that, well, they're lousy rules. The rule that was broken was the definition of assets under management. The SEC's rule is a model of simplicity - if you're comparing performance over a five year period, you average assets over that same five year period, and apply the ER adjustment to that average.
Some states (or towns, I forget) used to require the circumference of a circle to be calculated as 22/7 x diameter. Just because this was clearly stated, it didn't make the calculation correct. And just because Bridgeway defined AUM differently (to its advantage) in its prospectuses didn't make those calculations correct, either.
While I generally agree with you that "you can't eat risk-adjusted returns", the issue remains whether performance-based fees encourage excessive risk-taking. You write about targeting above average returns. Isn't that what nearly every fund (except index funds) does? It sounds like you want to push funds into taking more gambles. Likewise, your desire to "encourage management to target investment patterns above and beyond the index" would also seem to be encouraging increased risk.
Are you saying that it is the management companies, and not the actual managers, who "target investment patterns"? How would they do this, when it is the actual managers who decide what to buy and sell?
And wouldn't the same reasoning you applied to the fund managers (that they're already sufficiently motivated without performance-based fees) apply equally to the management companies? Don't they also benefit from good performance as their management fees rise along with growing AUM? Why is this sufficient motivation for the managers but not for the management companies?
Your comment on charitable donations is similarly confusing to me. You welcome Bridgeway funding of the Bridgeway Foundation (which in turn funds nonprofits), yet you denigrate nonprofits. You could make sure that you gave to directly to just those nonprofits that used the donations efficiently. How is it better to delegate donations to an organization (Bridgeway Foundation) that you don't control (unlike a donor advised fund) that might give some of the money to the "lazy" nonprofits? (This is not to demean BF, it is a conceptual question about your reasoning.)
I really want my manager do his/her best effort of finding securities that match its mandate. That is what I am paying them to do. I.e., for their expertise in digging into companies. Especially in small cap space there are many more to choose from. There are funds in the small cap space that are still able to that and still able to fully invest. The valuation metrics are close to ARIVX. I recently invested in VVPSX and I like what I am seeing there.
To your point about risk-taking: I am encouraging high volatility and high active share, not risk which is something else entirely that has to do with the personal consequences of not having the purchasing power you need at the time you need it. Management companies discourage this by limiting the scope of a fund's investment universe and, if you think about it, as the universe of investments available to an individual human manager shrinks it eventually becomes inevitable that he is guaranteed to track the index minus fees (because, in the limit, if the index only has 1 stock then there's nothing the manager can trade to distinguish himself). One of the worst things about Bridgeway, IMO, is that they limit their scope to domestic stocks even though their best and oldest funds do retain fairly broad mandates.
And, yes, you are correct that management companies are also already motivated without performance-based fees, but the problem is that they're equally motivated to obtain their profits by fooling investors (including those using "studies" to claim definitive "proof" as to whether or not the fund does indeed benefit investors) as they are by beating the market. So the motivation provided by performance-based fees are more specific to our goals as investors.
Finally, my comment regarding charitable efforts was not about the half of Bridgeway profits that goes towards the Bridgeway Foundation, it's about the other half which goes to the personal coffers of Bridgeway employees because it seems to me that these employees do more good for mankind with their personal resources (time afforded by having their expenses paid, etc) than the incompetent and sometimes dishonest fools working at the vast majority of nonprofits. So my idea is that the best way for me to make sure that I support efficient charity or do-gooding (which is not necessarily related to the government's ideas of "charity") is to ask the principals of that do-gooding to prove their ability to execute their visions by earning my financial support (under the same capitalist theory of competition I use to decide which businessmen will receive my dollars for their selfish and uncharitable visions) instead of undermining their own credibility by behaving like the helpless beggars to whom they're supposedly attempting to exhibit compassion (as in the typical nonprofit arrangement). This isn't to say that all nonprofits are inept, but on the continuum of charitable effectiveness I think it's best to first endorse "for-profit" do-gooders whose personal profits are in support of their personally charitable lifestyles, then nonprofits that might be well influenced by association with these paragons of humanity, and lastly nonprofits for whom charity is simply another job except without the pressure of competition to force them to get it right. I generally don't give money to nonprofits because I believe that charity is way too important to ignore the adage that "if you want something done right, you have to do it yourself" and, since the principals of Bridgeway seem to share a similar view, I hope that collaborating with them in my for-profit investment endeavors will prove an efficient way to achieve my overall goals as well.