The mutual fund industry is on the brink of big change. Already losing business to low-fee exchange-traded funds and robo-advisers, it faces new fee disclosure rules in 2017. There’s even talk of a ban on trailer fees, an established way of compensating commissioned investment advisers. The days of fund managers charging you 2% or more of your account’s value per year, plus front- or back-end loads when you buy and sell, are probably numbered.
What’s not clear is what will replace that standard fee model. For investors content to match the returns of stock and bond indexes, there are ETF providers. But what about the majority, who still want active management? A few fund companies have reduced their fees or eliminated certain sales charges without meaningfully changing the format.
But Chris Ambridge and his partners at Provisus Wealth Management have. Earlier this year, the Toronto-based portfolio manager for high-net-worth clients made a series of funds available directly to mid-market investors. Known as Transcend, the web-based service uses a pay-for-performance model in which management fees are tied to how much the fund beats its benchmark index, providing active management at a modest cost.
Here’s how it works: Transcend charges a base management fee of 0.25% of your investment per year—in the same ballpark as ETFs and about a tenth of the typical equity mutual fund’s management expense ratio—which Ambridge says covers his company’s basic operating costs. Then performance is tracked every quarter. If your fund beats its pre-set benchmark—say, the S&P/TSX or S&P 500 total return index—then Transcend collects 20% of the amount above that benchmark. If the index gains 10%, for example, and you earn a 12% return on your investment, you pay Transcend 20% of the difference, or 40 basis points. If you don’t beat the benchmark, you pay no additional fees.
“Everything I do—everything we’ve done here—is to be different,” says Ambridge, a veteran portfolio manager and chartered financial analyst who formed Provisus with colleague Wayne Murphy in 2007, when the firm they were working for seemed poised to fold. “With traditional commission or fee-based approaches, we think clients are paying probably a little too much for what they’re getting in terms of results and support.” Indeed, it’s rare to see more than half of actively managed mutual funds beat their benchmarks in any given year. According to the 2016 mid-year SPIVA Canada Scorecard, only 26.4% of actively managed Canadian equity funds outperformed their benchmark over the previous 12 months.
Ambridge argues that it’s the steep charges that prevent clients from beating their benchmarks in the first place. Even ETFs and robo-advisers never quite match market returns after their fees—averaging 0.32% for the former and 0.63% for the latter—are subtracted, he points out. Another common criticism is that maximizing returns simply isn’t a priority for many mutual fund managers, who make money from the size, not the performance, of clients’ portfolios. When investors become privy to all the charges they’re paying, and for what, many are expected to switch to advisers with better transparency.
Transcend is able to charge such low fees, Ambridge says, because a large portion of its services are automated and web-based—from setting financial goals to selecting and monitoring portfolios—yet still rely on the decisions of active fund managers. While he says the impending regulatory changes provided the impetus to get Transcend live, the idea goes back to Provisus’s origins. When Ambridge and Murphy surveyed clients at their former firm to gauge what was and wasn’t working for them, the most common demands were for a fairer payment model and better fund management. Provisus addressed those concerns by creating a hub of money managers (along with advisers and custodians), all with different styles and areas of expertise. “We recognize that one money manager cannot be all things to all clients,” says Ambridge. The other unique element was the offer of low base fees for portfolio management that increase only if investments outperform their benchmark.
Clients have responded favourably to Provisus’s offering: Revenues have grown 223% over the past five years, landing the firm a spot on the Profit 500 list of Canada’s fastest growing companies for three consecutive years. It now manages $425 million worth of assets, including $60 million in the upstart Transcend funds.
The success of Provisus gave Ambridge confidence that a similar service would likewise be a hit with a wider clientele—middle-class investors who were interested in actively managed pooled funds. Transcend goes by the same overall investment philosophy as Provisus: what Ambridge calls “active indexation,” which eschews taking bets on sectors or increasing its cash position. “We want to match the risk characteristics of the underlying benchmark, not take undue risks, and add value through security selection.”
Long before Transcend came into being, Ambridge showed a knack for anticipating trends. As an investment counsellor in the 1990s, he was an early user of Big Data to help insurance companies compare their performance to their rivals. During the dot-com boom, he developed an online investment newsletter, Midridge.com, of a kind that is now ubiquitous.
Ambridge doesn’t expect the rest of the industry to start aping Transcend’s fee format. “There’s a lot of history to the way the business operates,” he says. “Tradition is very important in the investment and fund management world.” But with the rise of financial technology, the landscape is changing, and this is a platform he thinks can compete. “There’s a lot of people who are very knowledgeable and skilled,” Ambridge says. “In order to stand out, you’ve got to either shout a little louder or shine a little brighter. And we prefer to shine a little brighter.”
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