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SEBI has streamlined the norms for charging of fees by portfolio managers, a move that will remove the ambiguities in the process of calculating performance fee.
On Tuesday SEBI passed the regulation wherein portfolio managers have been asked to compute profit on the basis of high water mark principle over the life of the investment, for charging of profit sharing fee.
Portfolio managers charge fees in 2 categories -- basic fees and performance fees. Currently portfolio managers usually charge performance fees after the portfolio crosses a benchmark or hurdle rate as is laid out in the agreement.
What Does High-Water Mark Mean?
High-Water Mark means the highest peak in value that an investment fund or an account has reached. This term is often used in the context of fund manager compensation, which is performance based.
The high-water mark ensures that the manager does not get paid large sums for poor performance. So if the manager loses money over a period, he or she must get the fund above the high watermark before receiving a performance bonus.
The following is an example of the way SEBI wants portfolio managers to calculate performance fee. Consider a portfolio where the client contributes Rs 10,000 initially. Let us assume that the performance fee is calculated annually in this case. The portfolio rises to Rs. 15,000 in a year. The client would have to pay the performance fee on the profit earned. In this case it is Rs. 5000. Suppose the next year the portfolio falls to Rs. 12,000. Here he will not pay any fee. Assume in the third year if the portfolio again rises and is Rs. 16,000. The client will have to pay a performance fee on the difference of Rs. 16,000 and Rs. 15,000 i.e. Rs. 1000.
Initial Contribution: Rs.10,000
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Year |
1 |
2 |
3 |
|
Portfolio Value |
15,000 |
12,000 |
16,000 |
|
High-Water Mark |
15,000 |
15,000 |
16,000 |
|
Profit to be considered for fee |
5,000 |
Nil |
1,000 |
SEBI circular said that in case of interim contributions or withdrawals by clients, performance fees may be charged after appropriately adjusting the high water mark on proportionate basis.
In order to ensure that investors are aware and understand the new regulation all existing clients are to be sent a letter as a supplement to the agreement about the applicability of the new high-water mark principle and the resultant new fees/charge structure. This annexure has to be signed by the client and sent back to the portfolio manager.
New clients are required to separately sign the annexure on fees and charges and add in their own handwriting that they have understood the fees/charge structure.
The regulation will be applicable for all new client agreements with effect from November 1, 2010. For existing clients, the revised terms shall be implemented by January 1, 2011.
SEBI came out with the regulation as it had been receiving complaints from clients relating to the fees been levied. On scrutinizing SEBI realized that there was ambiguity in the manager client agreement regarding the calculation of performance fee.
Also SEBI said that this regulation would bring uniformity, clarity and transparency with regard to fees and charges.
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