Sean Peche answers the call: responds to Coronation

For the past three weeks the issue of performance fees has been a big topic of discussion. Coronation recently responded in an interview on BizNews in the wake of detailed analysis by Ranmore Funds founder Sean Peche, which Coronation’s Pieter Koekemoer felt was “fatally flawed” and was “drawing conclusions that were completely unfounded”. After receiving several requests for a response, Peche answers the call below.

By Sean Peche*

Last weekend I penned a response to Coronation’s Pieter Koekemoer’s interview but then decided against publication – I didn’t want to get into an endless back and forth on the matter.

But after receiving several requests for my response this past week, I’ve changed my mind.

So, what did I think?

In summary, I thought we agreed on almost every issue, so was rather surprised to hear Pieter say, “that in our view, the analysis was fatally flawed” (7.11) and “drawing conclusions that we felt were completely unfounded” (58:15). To help you decide how “flawed” my analysis was, I’ve extracted parts of Pieter’s interview under each key point, adding some additional comment where I felt necessary.

1. Performance fees are extremely complicated

“The one fundamental problem you can never ever get away with for any kind of variable or performance related fee structure, is that it gets very complicated very quickly. It’s not simple.” (32.16).

2. Do South African retail investors really understand all the complexities?

“Where all the critics of performance fee structures are right, if these things are complex, the average investor won’t understand whether they’re getting ripped off or not. I fully agree with that.” (34.20)

3. Performance fees are not charged to retail investors in the UK and Europe 

“I think his point is valid.” (32.05)

 “The Irish regulatory environment is more prescriptive with regards to performance fee methodologies allowed in the jurisdiction than the South African regulator is and quite recently as a result of ESMA reforms, they’ve tightened up the allowed types of performance fees in the Irish market.” (14.35).

4. “83% of the AUM of the Top 10 non-income funds in SA have performance fee structures.” 

“There are a series of errors or omissions that I think were made in the process. The first one is the implication that most local unit trust funds have performance fees and that’s not factually correct.” (7.15) 

Except I didn’t comment on “most local unit trust funds”. I only commented on the top 10 non-income funds (03:45 – my BizNews presentation) and Pieter’s “implications” don’t make my comments, “not factually correct”. 

Industry insiders have said I’m wrong because most investors invest in “clean fee classes” via investment platforms that don’t charge performance fees (which charge an extra ~0.4% + vat)

Well, I drew my conclusions from looking at fact sheets of the largest funds on the fund manager websites, as any normal direct retail investor would do.

But it raises a new point – do direct retail investors who don’t invest via investment platforms, fully understand that they are investing in “dirty fee classes” and that there are alternatives? I fear not, because most fund managers I looked at, only produce one fact sheet per fund.

“Clean classes” or not, someone paid Ninety One ~R1.5bn in their 2021 & 2022 financial years and paid Coronation R1.5bn in their 2021 and 2020 financial years. 

Who?

If they were SA institutional investors with sophisticated advisors – fine.

If they were direct retail investors without fully understanding how these fee mechanisms work – not fine.

So improved disclosure is required and while we’re at it, perhaps all the unlisted fund managers like Allan Gray can enlighten us as to the extent of the performance fees paid to them and their group’s companies.

I’m sorry to say I miscategorised one fund and so want to modify my statement to, “65% of the AUM of the Top 10 non-income funds in SA have performance fee structures or 75% of the top 5” –  take your pick. 

5. Are South African investors paying more for the same product than UK investors?

“When we look at average fees in the South African unit trust industry compared to the UK onshore industry, our conclusion is that fees in South Africa are more expensive than in the UK but by a much smaller factor. It’s not double” (23.25)

Except I made no comment about the entire UK onshore industry, and only commented on the Top 10 non-income funds. I used Bloomberg data to extract the list, specifically highlighting at (05:25) that “a large number of these funds are trackers.” Also note, I said “less than 0.5%” – I was being generous.

I also only commented on Total Expense Ratios (TERs) not management fees. Since TERs include both management and administrator fees, any difference attributable to having independent administrators in Ireland isn’t relevant.

We produce a monthly factsheet that is approved monthly by our representative office in South Africa so am fully aware that the ASISA Standard CALCULATION AND DISCLOSURE OF TOTAL EXPENSE RATIOS AND TRANSACTION COSTS says The TER/TC must be calculated over rolling three year periods coinciding with a calendar quarter end and annualised.

But this suggests the TER should only be a few months out of date, not an entire year.

“Again, this is not an error in Sean’s analysis, this is confusion in the disclosure” (9.20)

I understand that comparing a TER using a 3yr average to 1yr performance is confusing, but General Principle 4 of the rules provides room for additional disclosure (which Coronation is now using). I did also compare the TER to 3yr performance for some of the funds and I’m afraid the conclusion was the same.

The 3yr TER calc may be industry standard but unless the underlying investors fully understand this, ASISA may want to review this.

Coronation has enhanced their 1year TER disclosure in the factsheets released on Monday and I think it’s much clearer. I haven’t seen other fund managers do the same.

I do agree that VAT charged on the management fees of SA funds is an unfair difference perhaps accounting for a 10bp – 15bp difference. Not sure that’s “fatal”

6. Performance fees were charged in South Africa where investors in the underlying fund weren’t charged performance fees

“It is indeed the case that in that one portfolio, Global Optimum Growth Fund we have a variable fee structure that adjusts up or down with performance in the Rand Fund, but we have a fixed fee structure in the Master fund in Ireland. And that is an anomaly. It is a different approach to what we normally adopt.” (12.43)

Pieter did go on to say that over the past year the Rand class charged 0.52% to account for underperformance, whereas the Irish fund continued charging 0.95%. I can’t see that 0.52% on the latest A Class fact sheet with updated disclosure so assume it’s a class issue (if it is, don’t forget the platform fee.) (09:20) 

7. Benchmarks in South Africa are often “soft” peer performance benchmarks and performance fees are often charged against these soft benchmarks

“Our Balanced Plus fund, which was the target of Sean’s initial piece… that’s included in the funds charging a fixed fee” (07:55)

Except I never accused Coronation Balanced Plus of charging a performance fee, and on slide 13 of my performance fee presentation, correctly reflect the fund as the ONLY one I was certain not to charge a performance fee.

“We would agree with the general statement that there is room for mischief at the benchmark level but in Coronation’s case, for the four equity and one equity biased funds that charge performance related fees, we only use formal market benchmarks. And we think that’s incredibly important” (26.20)

“So the benchmark you use should be something that is replicable, the investor should be able to buy that very easily in passive format, it should be credible, should be independent, compiled by a regulated index provider, the construction methodology should be in public domain and it should be main-stream index” (26.43)

I couldn’t have expressed this better myself, and was pleased to hear Pieter confirm Coronation doesn’t engage in this practice in any of their funds.

Unfortunately, other large SA fund managers can’t make this claim, so hopefully with Coronation’s Anton Pillay in the chair, this is up for discussion at ASISA.

Without wanting to open another can of worms, I’m also interested to know whether peer “clean” or “dirty” classes are used in the calculation of these peer group benchmarks because dirty performance fee classes would lower the hurdle even more. Does ASISA prescribe which class is to be used?

And since some of the large managers perform these performance fee calculations themselves, who is overseeing these complex calcs and stripping out performance of peers? Getting these calculations wrong would be a major risk – take note, auditors!

Nonetheless, this is not something Coronation needs to worry about.

8. Rolling High Watermarks providing the opportunities for, “multiple bites at the cherry”

Pieter didn’t comment on my issue of rolling high watermarks allowing daily crystallisation and “multiple bites at the cherry”. Perhaps this is because Coronation, like many, has rolling high watermark structures within some of their funds.

9. Disclosure needs radical improvement

“The one thing we learned from this debate is we can do better on the disclosure front. We can provide better information to show what is going on, not just meet regulatory minimums and we will start introducing that in the next factsheets for this past month.” (38.43) 

10. Benefits of scale have not been passed onto underlying clients

Let’s agree to disagree here on the basis that Ranmore’s TER of 1.4% is below that of funds 100x the size. At $200m our TER would be below 1%

So what now?

I think Coronation’s response increases the pressure on other managers to answer these questions:

  • Why do they charge performance fees that crystallise daily against “soft” peer benchmarks?
  • Which classes are used in the peer performance calculations – clean or dirty?
  • Who calculates these benchmarks and who checks their performance fee calculations?
  • Why are performance fees crystallised daily when clients are expected to assess investment performance over long term periods?
  • Which clients have paid their performance fees – institutional or retail?
  • Will they start disclosing the performance fees paid to offshore group companies? 

Other than Coronation and us, I couldn’t see any efforts to improve disclosure in the just published fact sheets, so either managers feel they’ve no charge to answer, or are hoping this matter fades away quickly. Unless investors start voting with their feet, it undoubtedly will.

But for me, I’m now done with this matter.

I need to devote my time to ensuring Ranmore keeps outperforming so we can increase our assets and execute on our pledge – to lower our management fees as we grow and donate at least 25% of revenue to charities and “worthy causes” chosen by clients. Hopefully some of you feel a little more empowered and enlightened. If you do, then my invested time has been worthwhile.

  • Sean Peche, Ranmore Fund Managers

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