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19 Feb 2015

THE VALUE AND IMPORTANCE OF CO-INVESTMENT

Investors often, and in good faith, entrust their hard-earned savings to professional fund managers. The fund manager is tasked with managing the investments in accordance with a written investment policy or mandate.

For taking this responsibility, fund managers are paid by the investors. But are fees incentive enough for fund managers to truly act in the best interests of their investors? PAUL CLUER examines the concept of co-investment.

It is trite that the interests of fund managers should be aligned with those of investors. Put simply, fund managers should be rewarded if, as a result of their actions and skill, investors sustainably enjoy superior returns. A good and widely practiced mechanism to align the interests of the fund manager and investor is to allow the fund manager to command a “performance fee.”

Performance fees allow the manager to share in a percentage of the return on the investment portfolio that exceeds the agreed benchmark return. By the same token, a fund manager should be prepared to allow investors to “claw back” or recoup fees (down to some minimal level) to ensure that a fund manager who underperforms a benchmark similarly feels the pain of loss. Fee rates that decline below the at-benchmark fee rate and high watermark arrangements are common examples.

However, alignment of investor and manager interests through the sole mechanism of performance fees and claw-backs is insufficient. In an extreme scenario, a fund manager may have all of their personal or corporate wealth invested in one asset class while investor funds are deployed into another. If the investment portfolio were to decline (either as a result of the market’s vagaries or the manager’s poor decisions), investors would suffer the effects of poor returns whilst the manager’s investment returns may be completely different.

It is for this reason that the most complete alignment of investor and manager interests is achieved not only with suitable fee arrangements but also with co-investment. Co-investment embraces the notion that the manager’s wealth should be invested similarly to that of the investors. In that way, the manager is exposed to the same risks as those in investor portfolios. Consequently, the manager’s discretion is exercised more keenly and astutely. It is the proverbial concept of “putting your money where your mouth is.”

Foord has embraced co-investment since the firm’s inception. Notably, the entire amount of the discretionary assets of the staff provident fund is invested in the Foord Balanced Fund unit trust. Companies in the broader Foord group invest their corporate working capital and reserves in the same Foord products as are available to direct investors.

The vindication of a fund manager’s skill might very well lie in the measure of investment by staff in the firm’s own products. At Foord, almost all staff, including analysts, portfolio managers and administrative personnel, have significant amounts of their own discretionary money co-invested in Foord’s unit trust funds.

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