Zweig Says Fees Should be Linked to Performance

The practice by many fund managers of charging flat fees to clients regardless of their performance isn’t fair to investors, says Jason Zweig of The Wall Street Journal. The tides are changing, he says, but not quickly enough.

Federal law allows a mutual fund to raise fees when it outperforms, but only if it lowers fees by the same amount should it underperform (a so-called “fulcrum fee”). However, Zweig writes, this isn’t the norm, and Warren Buffett seems to agree—in an email to Zweig, the Oracle said he plans on “writing extensively about fees” in his widely-anticipated letter to Berkshire Hathaway shareholders (due out in a few weeks) and that he hopes “more clients will demand lower fees.”

Zweig says that some investors think performance-based fees are an ” incentive for managers to take excessive risks” so they can collect more from clients, but he argues that flat fees “create similar motivations without offering any discount on the downside.” In fact, Zweig argues, researchers have found that funds with performance fees “can earn higher returns and be less likely to buy overvalued stocks.”

One manager, who charges based on performance for nearly 40 percent of his firm’s funds, says the performance with or without fulcrum fees “is roughly the same—but clients who have them tend to be more likely to stay put in market downturns, partly because they are more sophisticated and partly because they feel greater loyalty.”

“Fulcrum fees,” Zweig concludes, “are an old idea whose time has come again.”