LETTERS

Good idea, bad history

Your May 11 editorial advocating performance-based fees (“Fees for what you do, not what market does”) is right on the money, but you’ve missed some important history lessons.

The defined-benefit pension industry appeared to embrace performance-based fees in the late 1980s. Entire issues of prestigious industry magazines, such as the Financial Analysts Journal (January-February 1987) and the Journal of Portfolio Management (Summer 1987), were devoted to the subject. Most supported the performance-based fee arrangement, but few had meaningful solutions to the problems. I believe that these problems ultimately killed the idea.

The problems, many of which are still in the GTE program you cited in your editorial, are as follows:

Specification of a benchmark is essential. The 1980s industry seemed to want to use the S&P 500 for all mandates. We knew better then, and we certainly know better now.

The hurdle for additional compensation should be tied to skill, and therefore, market conditions and opportunities. The old practice of setting a 200-basis-point hurdle for all styles in all market conditions is absurd.

A longer time period, say three years, appears to be beneficial to the investor, but it’s not. The manager definitely benefits the longer the period.

In addition to these old problems, today’s financial planners need also to incorporate taxes into a fair performance-based fee arrangement. Beating the benchmark doesn’t mean much if it’s all paid out in taxes.

There is a technology that solves all of these problems, including taxes, called portfolio opportunity distributions, or PODs. PODs begin with the appropriate benchmark, and expand it into a scientific and pure peer group, so a manager is compensated on the basis of his ranking (translated as success).

The scientific peer group is constructed by forming all of the portfolios the manager could conceivably hold following his or her portfolio construction rules. In a poetic sense, the POD approach allows the manager to be hoist with his or her own petard.

RONALD J. SURZ

Managing director

Roxbury Capital Management

San Clemente, Calif.

And about the split?

Your May 18 editorial suggesting that there be a mandatory disclosure to clients by all advisers of commissions or other financial interests is a step in the proper direction. But how that information is to be given to the clients is equally important.

I have suggested to my state’s commissioner of insurance that the names of the recipient and amounts of commissions received be printed on each delivery receipt of all insurance policies and annuities sold. I have suggested this because there seems to be a movement among companies to license other professionals and to allow them to continue to conduct their primary business.

Often a client will listen to a trusted adviser, be it an attorney or accountant, thinking that the adviser does not have a financial interest in any sale. The adviser refers the client to someone who can provide the service and when the sale is completed, the provider and the adviser share the commission. That purchase may well have been in the buyer’s best interest, but I believe consumers should know when the adviser has a financial stake of which they are not aware.

To arbitrarily ban a group of professionals from providing financial advice is akin to the adage about the baby and the bath water.

MORRIS ARMSTRONG

Certified financial planner

White Plains, N.Y.

Related Topics: At The Bell