SQM Research Ratings Update

This week we focus on an important factor that investors consider while choosing a managed fund (within a sector) â€“ the fees.

Most of the funds that we are in the process of rating as part of our global property securities and global infrastructure securities fund review, charge fees in line with the broader peer average. The fees for both the global property securities sector and the global infrastructure securities sector peer groups are in the table below.

Source: van Eyk, fund PDSs, SQM Research. ^ As at 30^th June 2013.

Some of the funds that we rate also charge a performance fee in addition to the management fee and expense recoveries. For these funds, at the end of each financial year, the performance fee charged - if any, is reflected in the reported indirect cost ratio (ICR) which includes the base management fee and any expense recoveries as well as the performance fee. Therefore, it becomes important for investors to compare not only the management expense ratio (MER) but also the ICR, especially for funds that charge a performance fee.

From the funds that we are in the process of rating, Resolution Capital Global Property Securities Fund is the only fund within the global property securities peer group that charges a performance fee. Within the infrastructure securities space, Magellan Infrastructure Fund, RARE Infrastructure Value Fund and the RARE Emerging Markets Fund charge performance fee.

From the table above, specifically for the infrastructure securities fund peer group, a difference between the MER and ICR is seen. This gap has primarily stemmed from the performance fee charged, which added to the ICR at the end of the financial year.

SQM Research remains unbiased towards the adoption or performance fee. However, believes that the performance fee measures should be in line with the long-term objective of the fund. SQM Research believes that the following factors should form the basis while determining an appropriate performance fee by an actively managed fund:

The performance of the fund should be measured against an appropriate benchmark. This is especially true for active funds that aim to generate alpha (or outperformance) by adopting rigorous research and conviction into their stock selection process. Therefore, a broad, â€œeasy to beatâ€ benchmark might result in the fundâ€™s investors having to pay a large proportion in performance fee, which would be detrimental to the total return they receive on an after-fees basis.
The fund should apply an appropriate hurdle rate, which is the return generated by the fund over its chosen benchmark index.
The performance fee charged by the fund should be subject to a high water mark which means that the fund must first recover any previous underperformance before being eligible for a performance fee. This also includes the situation where a fund might outperform the benchmark but record negative absolute returns.

In summary, the ultimate decision rests with the eventual investor. It is our advice to the investors to be prudent in their approach and measure whether the fees being charged by the fund manager are cognizant with their investment approach and objectives and whether the fee structure is best suited for the investor or the fund manager themselves!

Some Comments About NRAS From Managing Director, Louis Christopher

There was a report in The Australian today citing that the National Rental Affordability Scheme has largely failed in achieving its objectives, which were at one point, to construct 50,000 dwellings. SQM Research has overall been favourable to NRAS, but has been disappointed by its execution and delivery.

One of the main problems behind the scheme was that it was originally targeted towards institutional investors. However, most institutions did not invest in the scheme and so it was then allowed to be aimed towards retail investors but without the proper safeguards in place.

SQM Research had a rating on Questus, one of the largest providers of NRAS schemes. As at January 2014, that rating, (which was 3.75 stars) and report had expired and Questus has not sought a new review.

You can still find the expired report here under our ratings research subscription.

SQM Research still believes that NRAS has merit and is hopeful that the National Liberal Government will amend the scheme to make it more tuned to retail property investors with further safeguards in place for those very investors.