• Trustees Corporate Supervision

May 2, 2022

Morningstar report questions fund manager fees

New Zealand downgraded to average in world rankings for fund manager fees and expenses

At the end of March 2022, global investment information service Morningstar published the first chapter of the seventh edition of its more-or-less biennial Global Investor Experience study (“GIE”).  Morningstar breaks down the GIE to three topic chapters, published sequentially across a year:

  • Fees and Expenses
  • Disclosure
  • Regulation and Taxation

The newest, 57-page GIE Fees and Expenses is concerned with ranking 26 countries, New Zealand included, for the fees and expenses charged by managed funds on offer in their jurisdictions.  This GIE can fruitfully be read in conjunction with the FMA’s April 2021 Guidance Managed fund fees and value for money (“Guidance”), because both documents are essentially addressing the same things, namely how managed fund fees can represent value for money for investors and what should be done if there is a “value failure”. Published a year apart, the GIE and the Guidance traverse convergent themes and share common attitudes to some of the fees charged by many managed funds to their investors. 

Whereas the Guidance was written by a regulator understandably focused solely on the New Zealand context, the GIE comes from a different angle because it compares and relativises New Zealand’s managed funds market within the global context.  The two documents complement each other.  In this article, we will examine the common threads between the GIE and the Guidance concerning managed fund fees, in particular controversies over performance fees and trail commissions.

Spoiler Alert: New Zealand drops a notch

The table below shows the results for 26 countries Morningstar graded from best to worst in terms of the burden of fees and expenses charged to retail investors within the available universes of managed funds.  Many of these countries ring-fence their managed funds markets by permitting their resident retail investors to access only locally-domiciled products.  Of the 26 countries analysed, six improved their rankings by a notch since the last fees and expenses GIE conducted in 2019, whilst four, including New Zealand, fell a grade.  The top ranking countries were all praised for depressing or eliminating certain managed fund fees and expenses and can be regarded as international examples of “what good looks like”.

Table 1: Morningstar GIE Fees and Expenses country rankings published 30/3/2022




Australia, Netherlands, United States

Above Average

Korea*, Norway*, South Africa*, Sweden, United Kingdom


Belgium*, Denmark, Finland, Germany*, India, Japan, New Zealand**, Spain*, Switzerland**, Thailand**

Below average

Canada, China**, France, Hong Kong, Mexico, Singapore


Italy, Taiwan

*Denotes grade promotion since 2019; **denotes grade demotion since 2019

(GIE, p. 9)

More on New Zealand’s Morningstar report card later on.  In the meantime some of the GIE’s methodology and high level observations will be examined first.

Morningstar’s methodology and general observations

Separately published from the March 2022 GIE, Morningstar issued a short, related paper, Global Investor Experience Methodology: Fees and Expenses (“Methodology”, published 30 March 2022) on the methodology used to underpin the GIE’s findings and conclusions.  It is useful to read this paper in conjunction with the GIE, not least because its list of the six survey questions that were asked across 26 countries reflects some key concerns of the FMA’s Guidance.   

Tellingly, the questions focus on “retrocessions” and performance fees, which are treated by Morningstar as potentially detracting from investor experience with managed funds.  In New Zealand, the term retrocession is not commonly used to describe managed fund fees, but the most typical examples found here are investment entry or exit fees, embedded trail commissions, and bundled advice fees paid out by fund managers to compensate distributors of their investment products such as banks and financial advisers. 

Morningstar’s six survey questions are as follows:

  1. Are all sales loads and breakpoints fixed, or are loads negotiable?
  2. Are funds permitted to charge asymmetrical* performance fees?
  3. Do fund documents disclose the relevant terms of the performance fee such that an investor can accurately estimate expenses?
  4. Is it common for investors to pay for advice outside of commissions and expenses?
  5. When purchasing funds without advice, are investors able to easily buy funds without loads?
  6. When purchasing funds without advice, are investors able to easily buy funds without trail commissions?

*Asymmetrical performance fees are defined by Morningstar in its GIE as “meaning that funds can charge additional fees for outperformance, without an equal reduction in fees for underperformance” (GIE, p. 42, in explicit reference to New Zealand).

(Methodology, p. 1)

These questions pose a shortlist of fees earmarked for fund managers to self-reward their own performance in generating managed fund returns (questions 3 and 4) and to pay sales and support incentives to their fund distributors (questions 1, 2, 5, 6).  Based upon the collective responses to these questions across 26 countries, Morningstar has generated its GIE for 2022.  As an overall observation, the presence of loads, performance fees and retrocessions is regarded by Morningstar as a negative, particularly when compared with no-load, no-retrocession exchange traded funds (“ETFs”).

The GIE is a substantial report and there is only limited space available in this article to analyse what it states in its entirety.  However, some of the report’s high-level observations are particularly noteworthy.  Overall, in most of the 26 countries surveyed, managed fund fees have been reduced since 2019.  Retail investors have been migrating their money towards lower-cost managed funds as the long-term investment returns importance of minimising fee impacts has become more widely understood.  Some countries (Australia, India and the Netherlands) have effectively banned front load fees and trail commissions. Trends towards retail investor DIY and fee-based financial advice (Australia, US) have stimulated rising consumer demand for low-cost passive funds such as ETFs that do not have load, trail commission, or advice fee charges embedded within the cost of investing into them. 

Morningstar makes an interesting observation on how managed fund fee reductions may alternatively be driven either by direct regulatory interventions in smaller markets or by sheer scale effects in larger markets:

Regulatory drivers explain the low asset-weighted median expenses for the Netherlands, while the economies of scale achieved by larger fund markets such as the United States, Switzerland, the United Kingdom, and Australia explain their leading positions.

(GIE, p. 12)

New Zealand, because of the relatively small size of its market, would probably sit closer to the Netherlands in requiring regulatory intervention to drive down managed fund fees, such as the FMA’s Guidance and incoming annual managed fund value-for-money assessment regime represent, but with the growth of funds invested in KiwiSaver may eventually be moving more in the direction of large economies-of-scale markets like Australia.

Expressly on the managed fund fees value-for-money front, the GIE observes:


One of the most significant regulatory developments since our 2019 study is the introduction of annual assessments of value in the UK. These require asset managers to substantiate the value that each fund has provided to investors in the context of the fees charged.

 (ibid., p. 15)

New Zealand:

There have not been any material regulatory changes related to fee disclosure since our 2019 Fees and Expenses study. At the same time, the Financial Markets Authority, which is the primary regulator, has required the industry to assess the products they sell to be ‘fair value.’ This has led to fee reductions in some products.

(ibid. p. 42)

Managed fund fee controversy No.1: Are retrocessions going out of style?

The GIE devotes considerable space to “bundled” fees embedded within managed fund fees, variously calling them retrocessions, commissions and trails.  The Netherlands is repeatedly praised for scrapping retrocessions in 2014 and its top grade ranking is substantially ascribed to this action.  It is clear that Morningstar is not approving of such fees being automatically deducted from investor capital to pay managed fund distributors where it writes:

While acknowledging that within a bundled-fee environment the investor experience can be adequate, Morningstar maintains that by lowering the cost of investment products via commission-free share classes and by unbundling other expenses from the cost of investment management, investors benefit from greater choices and improved transparency. In addition to lowering all-in costs for do-it-yourself investors, those participating in a fee-based advice model may accrue additional benefits from more individualised service, including savings guidance, tax planning, and pension optimisation, which collectively add significant value to the investor experience.

Additionally, when paying directly for advice, an investor can avoid the inherent conflict of interest that occurs when advisers are compensated for promoting specific products. In the worst possible outcomes from ‘bundling,’ investors run not only the risk of receiving poor quality advice, but of receiving no advice at all.

(ibid. p. 6)

This position fits in with that expressed in the FMA’s Guidance, wherein it is stated regarding bundled advice fees:

In all cases, offering advice or services of any kind is not evidence of it providing value for money. To claim value for advice or service, particularly if it carries or contributes to a fee paid by the member, managers should evidence that the advice and service is received i.e. used or acted upon with positive impact…

From a value for money perspective, we want to ensure there are as few barriers as possible to New Zealanders getting the help they need to make good investment decisions. However, we want to avoid a situation where fees for advice are embedded within broader fees paid by all members, are not transparent to members, and result in schemes competing to make offers to advisers to ‘buy’ members from them.

We prefer that fees for advice are charged to the member, not the scheme, or are otherwise structured so members can choose not to pay the fee.

(Guidance pp. 9-10)

Nonetheless, in respect of retrocessions in New Zealand’s market, Morningstar approvingly states, “Funds without trail commissions are also accessible to the average retail investor given that fund distribution is common via an adviser or through more modern direct-to-consumer platforms.”

(GIE, p. 42)

Managed fund fee controversy No. 2: Performance fees hurdle rates under challenge

Morningstar pays significant attention to performances fees throughout the GIE, expressing a mixed opinion on them:

We view performance-based fees favourably only when structured to appropriately align management’s interests with fund shareholders’. Best practice for performance fees includes the use of an appropriate benchmark and emphasising long-term periods in measuring performance. In addition, we prefer fulcrum fees that symmetrically adjust the fund’s fee upward or downward in direct proportion to any outperformance or underperformance. Finally, the upward adjustment shouldn’t be so large that it takes the fund’s expense ratio well above its peers’ average. It remains instructive that in the United States, where performance fees are required to be symmetrical, those fees are exceedingly rare within mutual funds.

(ibid. pp. 6-7)

It is telling that in relation to performance fees, in its “Key Takeaways” the GIE singles out New Zealand for some critical commentary:

Appropriate performance-fee structures and disclosures remain a watch area for Morningstar.  In markets like New Zealand where there is no prescription by regulation for the performance-fee benchmark to be appropriate and tied to the asset allocation of the fund, this has led to some inappropriate benchmarks being used as hurdle rates by local fund managers. Large performance-fee earnings that reflect market movements rather than manager skill have been evidenced in recent years.

(ibid., p. 8)

Hurdle rates are pre-specified investment return levels for managed funds above which fund managers can reward themselves by deducting performance fees that are ultimately charged back to fund investors as correspondingly reduced returns.  Performance fees in effect represent profit-sharing schemes between fund managers and their investors, with a portion of the outperformance of the fund above its hurdle rate reverting to the manager.  In theory at least, performance fees align the interests of fund managers with their investors by incentivising the managers to achieve outperforming returns on their investment activities.  Consequently, the hurdle rate that is used to set the manager’s entitlement to be paid performance fees is a critical consideration when assessing whether any such fee represents value-for-money to investors.

In the section dedicated to explaining New Zealand’s demotion to “average” grading, the GIE expands upon its performance fee concerns, which centre upon “asymmetrical” performance fees and “inappropriate benchmarks” serving as hurdle rates.

Funds in New Zealand are permitted to charge asymmetrical performance fees, meaning that funds can charge additional fees for outperformance, without an equal reduction in fees for underperformance. Fund documents disclose many of the relevant terms of the performance fee to help investors accurately estimate costs for the year. They must estimate the performance fee in percentage terms and include this in their forward-looking estimate of fees and costs. There is no prescription by regulation for the performance fee benchmark to be appropriate and tied to the asset allocation of the fund. This has led to some inappropriate benchmarks being used as hurdle rates in the New Zealand market. Large performance fee earnings, which reflect market movements rather than manager skill, have been evidenced in recent years. This is commonly seen with equity funds that use cashplus benchmarks. Couple this with asymmetrical performance fees, this ensures a performance fee structure that is optimized not for investor returns but instead for the fund manager’s benefit.

(ibid., p. 42)

Morningstar’s comment about “no prescription by regulation for the performance fee benchmark to be appropriate and tied to the asset allocation of the fund” is borne out when we consider the relevant regulations within the Financial Markets Conduct Regulations 2014 (“FMCR”).  In FMCR Schedule 4 Part 4 Fund Update section clauses 59 and 61 the use of an “appropriate market index” is defined for the comparison of fund returns to market returns in quarterly fund updates.  In particular, FMCR Schedule 4 clauses 59(6) (a), (b) and (c), and 61(3) (a) and (b) spell out what makes a market index eligible for evaluating fund performance, including that the measure must be “appropriate in terms of assessing movements in the market in relation to the returns from the assets in which the specified fund directly or indirectly invests.”

By comparison, FMCR Schedule 4 Part 1 PDS for managed funds clause 33, which specifies the rules for disclosing performance fees in a PDS, is silent on the type of managed fund that a performance fee can be applied to. This clause also leaves open the possibility that the hurdle rate of return that needs to be achieved before a performance-based fee can be charged might be a measure other than an appropriate market index as specified under FMCR Schedule 4 clause 61.  This opening to other possibilities is signalled by inclusion of two conditional subclauses: “If there is no hurdle rate of return that must be achieved before a performance-based fee applies, the PDS must include a statement to the effect that no minimum return must be achieved before a performance-based fee applies,” and, “If a performance-based fee may be paid even if the fund does not achieve (after fees but before tax) the return of the market index that is used for the purposes of clause 61, the PDS must include a statement to that effect.”

For the gap that Morningstar has implicitly identified to be bridged between FMCR Schedule 4 clauses 33 and 61, clause 33 would need to be modified to state that the hurdle rate of return must also be an appropriate market index as specified in clause 61, or, more stringently, that the hurdle rate of return must be based upon exactly the same appropriate market index as is specified in the related managed fund’s fund update (e.g. fund update index + X%).

The New Zealand government has addressed the question of performance fees several times in the past, including in the April 2021 value-for-money Guidance.  An early reference to performance fees is to be found in Guideline No KSGN2 : Performance Fees and Ethical Fund Fees, an undated one-pager issued by the Government Actuary which sets out criteria for determining whether a KiwiSaver scheme’s fund performance fees are not unreasonable.  Of note, the Guideline states:

Performance fees, by their very nature, should reflect out performance for a specific fund.  Usually the assets underlying such a fund are in equities.  Where such performance fees are defined, it is usual to have a lower base fee.

The FMA goes into performances fees in more detail in a three-page information sheet dated February 2016, entitled How performance-based fees should be disclosed (“Information Sheet”), which was written to unpack the legal meaning of FMCR Schedule 4 clause 33.  The information sheet states that it “outlines how we expect fund managers to disclose performance-based fees to investors” (Information sheet p. 1).  Of note this document contains the following extended section which clearly recognises that a managed fund’s performance fee hurdle rate of return may not be identical with its appropriate market index:

Performance-based fees calculated using a different market index

8. Under the Regulations, all managed funds are required to report their performance as part of the fund update. This performance must be measured against the returns of an appropriate market index. The market index used must appropriately reflect market movements in the types of assets that the fund invests in (comparative index). Although not a legal requirement, it is reasonable to link the hurdle rate for any performance-based fee to the returns of the comparative index [our emphasis].

  1. Some funds currently base their performance fee on a hurdle rate of return linked to a market index that does not reflect the asset class and risks of the underlying investments. An example is equity-based funds that use a 90-day bank bill index as the hurdle rate of return. The impact of this is a fund may still be paid a performance-based fee although it has underperformed against the fund’s comparative index.
  2. Where a fund’s hurdle rate of return is linked to the performance of a market index different to the comparative index, this should be clearly disclosed in the PDS so that prospective investors understand the implication. The following is an example of language that a manager could use for this purpose:

Sample disclosure when a fund uses a different market index

Our performance fees are based on a hurdle rate of return. The ‘hurdle rate’ is the minimum return the fund must achieve before being able to charge a performance fee, and is determined by a market index.

In our fund update, we compare the fund’s performance against the [insert market index]. Our view is this index provides the best comparison of how the fund should perform.

However the hurdle rate of return for the performance fee payable to us is based on [insert market index]. This means you may be paying a performance fee even if the fund’s performance does not match or beat the market index which has more comparable assets.

  1. The wording above is not prescribed. Managers may use alternative language which they feel better suits the nature of their fund and the basis on which performance-based fees are charged. It is important, however, that any alternative wording makes it clear to investors that two different market indices are used, and the consequences this has for investors.

(Information Sheet, pp. 2-3)

With the advent of the FMA’s value-for-money Guidance in April 2021, under the heading “Performance fees – useful questions for managers and supervisors”, the expectations of the regulator are stated somewhat differently than in 2016 with respect to performance fees that are based on hurdle rates of return that are unrelated to the appropriate market indices used for fund performance measurements:

  • What qualifies as ‘performance’ to earn the fee? Is it judged relative to a benchmark – and is it the same as the market index chosen for the fund, or different? For example, it is not in members’ best interests to pay a fee for outperformance of a cash-based benchmark for an equity-based fund, as the risk of the benchmark and the fund are materially different and the benchmark will, over time, be simple to beat (and so does not represent value added by the manager).

(Guidance, p. 8)

The quoted section above in turn refers on to the Guidance note KiwiSaver Performance Fees (“KiwiSaver Guidance”) first published in May 2012 but updated in April 2021 to coincide with publication of the value-for-money Guidance.  The purpose of the updated KiwiSaver Guidance is stated as, “This guidance note sets out the criteria against which we will assess whether any performance fees that are proposed to be charged, or are charged by a manager to a member’s investment in the Scheme can be considered ‘not unreasonable’” (KiwiSaver Guidance frontispiece page).

Reference is made in the KiwiSaver Guidance to fund managers being expected to select “appropriate” performance fee hurdle rates of return.  For example, under the heading “Performance fee elements”, “Hurdle Rate of Return with an appropriate benchmark” is listed as a “key element” (KiwiSaver Guidance, p. 2).  The KiwiSaver Guidance goes on to state:

The Hurdle Rate of Return should reflect:

  • The long-term objectives and inherent risk characteristics for the fund concerned (in general the higher the risk, the higher the required hurdle).
  • An appropriate return benchmark, generally the expected return from the standard fund asset mix under normal expected market conditions before allowance for ‘added value’ from active management. The benchmark should be based on a suitable market-related index, adjusted where necessary for the inherent risks and potential returns within the fund concerned. We accept that, for a true ‘absolute return’ investment fund, a cash-based benchmark, e.g. 90-day bank bill rate (BKBM), may, in certain circumstances, be an appropriate benchmark. In these circumstances we would expect the fund’s track record over time to reflect the ‘absolute investment style’.
  • If appropriate, an allowance in the minimum Hurdle Rate of Return where there are active management fees already implicit in any base fee.

(ibid. p. 2)

The quoted statement from the KiwiSaver Guidance is softer and more liberal in tone with respect to use of cash-based hurdle rates for performance fees applied to equity-based funds than the Guidance, and in that respect is closer to the earlier Information Sheet. 

It is evident that in the case of performance fee hurdle rates, the views expressed by the FMA have shifted somewhat over time, but in general that these views have reflected the state of regulation in New Zealand and anticipated the position taken by Morningstar.  With respect to retrocessions, typically trail commissions in the New Zealand context, the views expressed by Morningstar are close to those evinced by the FMA in its value-for-money Guidance.


“A lot of attention will be paid to value for money in fund manager fees over 2022 as the FMA finally beds in the assessment regime that it expects will be implemented going forward by managed investment scheme (“MIS”) managers and their licensed Supervisors,” said Matthew Band, General Manager of Corporate Trustee Services at Trustees Executors.

“The FMA’s Guidance Managed fund fees and value for money (“Guidance”) has set out the tone and ambit of these assessments, in particular expressly looking at the likes of embedded trail commissions and bundled advice fees, alongside how performance fee hurdle rates of return relate to appropriate market indices used for fund performance measurement.”

“Morningstar in its Global Investor Experience - Fees and Expenses has come to conclusions very similar to the FMA’s about issues with managed fund fees, albeit from a global best practice perspective in which New Zealand was just one of 26 countries sampled.”

“The FMA is now consulting with MIS Managers, as it has done already with licensed Supervisors, concerning best practices for ongoing annual application of value-for-money fee assessments to individual managed funds.”

“We would urge MIS managers to look outside the ambit of the FMA’s Guidance when responding to the funds management industry consultation currently underway and take into due consideration what respected overseas commentators such as Morningstar have contributed to the worldwide debate taking place on fund manager fees and how they can be shown to provide value to investors.”

For comment or more information, or to be added to the free email subscriber list of “The Supervisor”, please contact Matt at [email protected] 

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