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What are Fulcrum Fund Fees?

Fidelity have introduced a new type of performance fee called a fulcrum fee. Morningstar's Chris Traulsen explains the pros and cons

Emma Wall 6 December, 2017 | 9:30AM


Emma Wall: Hello and welcome to the Morningstar Series, "Ask the Expert". I'm Emma Wall and I'm joined today by Morningstar's Chris Traulsen to talk about fulcrum fees.

Hi Chris.

Chris Traulsen: Hi Emma.

Wall: So, I suppose the first and most obvious question is what is a fulcrum fee?

Traulsen: It's a funny sounding name isn’t it? It's a type of performance fee and when you think about our regular performance fee. The manager is essentially taking a free call option or more money, he might charge 1% a year in ongoing charges, but he might get up to 20% if any outperformance than the standard performance fee arrangement, which we think is terrible by the way. And the fulcrum fee is somewhat better in that it forces a symmetric penalty or reward on to the management fee as a performance fee.

So, if he has 1% management fee for example if he underperforms by a certain amount he might gain an extra 15 basis or loose an extra 15 basis points and only charge 85 basis points that year. If he outperforms by the same point he might add 15 basis points and charge 115 basis points. So, there is a certain fairness to it that isn’t present with a standard performance fee.

Wall: Now that sounds very positive, but it also sounds quite complex. I mean other than complexity, are there any negatives that could be levied on this.

Traulsen: I mean I think in first place, any performance fee is dependent on it's design. Right. So, if the base fee is high to start with there is no reason why they should be earning a performance fee. If you think about it your typical active manager is compensated by an enormous amount in excess of what a typical passive fund would charge. The only reason you would pay that as an investor is because you expect them to outperform. So, this whole notion that they need extra pay to motivate themselves to outperform is a bit of nonsense.

So, the first thing is, is it charging a materially below average or below median relative to similar funds base fee. I think second thing is they could choose a benchmark that's not relevant or very easy to beat. So, you want to make sure that if everybody else is beating the benchmark, they should really be using that benchmark plus a hurdle rate or a more competitive benchmark otherwise they are in fact giving themselves a free call option on more money.

So, there are some downsides there in terms of gaming the system. As you can tell from the way I have described it there is complexity and you don’t have certainty as to outcome. And also with performance fees, like they are so typically done relative to a benchmark and you need to keep in mind that means if the benchmark loses 20% and you are manager loses 18% they will get a positive performance fee, because they have lost less the benchmark, which might be okay in some investor's minds. But compensating people extra for a loss bothers you you may wish to stay way from such fees.

Wall: Now we are talking about this because Fidelity have come out and introduced fulcrum fees on a number of their funds. Where the U.S. goes the U.K. tends to follow, can we expect more fulcrum fees being rolled out. What is the take up in the U.S.?

Traulsen: Take up in the U.S. is actually quite small. Fidelity is a leading proponent of them in the U.S. So, I think in the U.S. we track less than 1.3% of active funds with fulcrum fees. And in the U.S. when you have performance fee it has to be a fulcrum fee if it’s a registered mutual fund, they don’t allow you to have another type. And it has to be symmetric, that is the penalty has to be equivalent to the reward. So that’s a good thing. But not many fund houses use them I suspect because they don’t like that aspect of potentially losing a chunk of their management fee. There is also the administrative complexity.

So not a huge take up in the U.S. I think this is more of a Fidelity situation. Abby Johnson, Head of Fidelity in the U.S. is also Chair of Fidelity International which has implemented this and at the same time she wrote an editorial in the FT lauding the benefits of fulcrum fees. So, I think it’s a little bit more of a Fidelity issue than U.K. follows the U.S. issue.

I will say that we're seeing more and more experimentation with fee structures given all the new regulations and rules and regulator's emphasis on being more competitive with fees and being more transparent with fees. And we've yet to see where that will go. There doesn’t seem to be a central tendency, but fulcrum fees are certainly part of that equation in the U.K.

Wall: Chris, thank you very much.

Traulsen: Thank you Emma.

Wall: This is Emma Wall from Morningstar. Thank you for watching. 

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About Author Emma Wall

Emma Wall  is Senior Editor for