Wednesday, April 8, 2009

Mutual Fund Performance based Asset Management Fees and Compensation Policy

Most of the Mutual Funds in the Industry have flat Asset Management fees and Asset Manager Compensation Policy. This needs to be changed. Previously I had suggested a compensation policy in line with Hedge Fund. It should have a low flat fee and Percentage of Profit sharing above the High water Level level(meaning the Profit sharing starts only after a Benchmark return is achieved). I can think of another improvement over this plan. We can have an Industry standard set for all Mutual Funds for following this policy. Let me provide the outline of this policy. We should have a Benchmark set for each MF. Also we should have a Record Date for Uniformity in Performance Measurement(many MFs show their best return period in their advertisement which does not truly protrait their performance). For example for a Diversified Equity Fund the Benchmarking Index can be Nifty. The record date can be January 1 of each year. The Asset Management Fee structure will be as follows:
Return Below Benchmark return(Does not matter if the return is Positive or Negative, in a bear market less negative means good performance)- A small Fixed Asset Management Fee. Say .25% of the Asset under Management(AUM)
Return matching Benchmark return .5% AUM
Return more than Bechmark return not exceeding 10% - Asset Management Fee should be 1% AUM
Return more than Benchmark return exceeding 10% - Asset Management Fee should be 2% AUM
Out of this 50% of the compensation should be in cash and 50% of the compensation should be in managed fund's unit having a lock in period of at least 3 years.
These numbers can be changed but this should be the compensation philosophy.