Research by Chant West Financial Services claims that making fee comparisons across super funds is “highly misleading”, because many fund-of-funds in the alternatives asset sector are understating their real fees. STEPHEN SHORE reports.

A number of fund managers have been increasing their exposure to alternatives recently. Mercer Investment Consulting ran 20 per cent more searches for alternative asset managers in 2007 than it did in 2006, and according to Chant West, industry superannuation funds have, on average, doubled their allocation to alternative assets (from 7 per cent to 14 per cent) over the past two years. But comparing these investments has become difficult for investors because many of these alternatives (such as private equity, infrastructure and hedge funds) are accessed through fund-of-fund vehicles, where there is almost universal non-disclosure of underlying manager fees – both base fees and performance fees, the report says.

For example, the most common objective in a hedge fund-of-funds product is to earn the cash rate plus 5 per cent per annum, net of all fees (about 12 per cent in today’s market), the report says. “What is little understood [by fund investors] is that, in order to do this, the product has to earn about 20 per cent per annum gross.”

This is because the total fees can amount to about 8 per cent, leaving the investor with about 12 per cent. Typically, only the lead manager’s base fees and performance fees are disclosed – around 2 per cent – leaving the underlying manager’s base fees, administration costs and performance fees – around 6 per cent – undisclosed. In this example, if fund-of-funds alternatives represent 5 per cent of a super fund’s total assets, then the overall management cost will be understated by 30 basis points, the report says.

“This is a material figure given many funds report management costs in the range of 60 to 80 basis points. And if fund-of-fund alternatives represent 10 per cent of total assets, overall management costs will be understated by 60 basis points (and at 20 per cent it is 120 basis points).

“Non-disclosure of fees in the alternative asset sector is a chronic problem facing the industry, and one that needs to be addressed urgently,” the report says. “It severely hinders fee comparisons across funds, and leads investors to be inadequately informed about the costs they may incur.”

Ian Fryer, research manager at Chant West, says that while the report is primarily referring to fund members being unaware of the true cost of their fund’s investments, even some funds managers are not fully aware of the underlying fees in this asset class. “We had some contact with one major superannuation fund, where it hadn’t been clearly communicated from the asset consultant what the fund was actually paying. A 12 per cent return net of fees may sound reasonable if you think the fees are only 2 per cent. But if 12 per cent net-of-fees return means 20 per cent gross, you may begin to question whether that is achievable – especially as more people enter the alternatives space and it becomes harder to get those returns.”

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