Mutual funds fees: It's time to shift to pay-for-performance

By Money Matters Editors

A trading colleague known by Money Matters Editors had a phrase that he used to cite when he heard a trading idea that was curious, at best.

He would say, “That makes no sense, whatsoever.” And the idea was usually subsequently tossed in the trash can.

The same can be said about guaranteed fees in the mutual fund industry, including management fees and load fees. Note that we said mutual funds, not hedge funds. Today, we’re addressing those funds that typical Americans have invested trillions of dollars in: mutual funds.

Simply, guaranteed fees for mutual funds must stop. They’re part of a pre-financial crisis era culture that lavished large salaries and bonuses on financial professionals….for non-performance – in other words guaranteed pay. That model has been discredited and that era is over.

The new standard is pay for performance – and that’s the only fair system: if you earn a return, you’re paid. If not, you’re not. Mutual funds should only pay a modest salary to administrators: the rest should be performance-based. Further, no one would be in deprived circumstances under the new system: salaries will still be high enough to attract talent – only the excess, waste, overpayment, and absurd ‘payment for non-performance’ will be eliminated, to the benefit of shareholders. Mutual fund professionals will still earn median salaries well above what typical Americans make: what will be gone will be $1 million salaries and $2 million bonuses for a fund that earns no money two years in a row.

The above will help end the standard mutual fund sector alibi: When the fund performs well, mutual fund administrators chime, “We earned a great return this year. We did a great job.” But when the fund underperforms, administrators chime, “The market fell this year, driving the fund’s value lower.” 

Guaranteed fees make no sense, whatsoever. It is pay for non-performance. Pay for performance is the fairest system: you eat what you kill.