Origination of complex investment management fee structure

Fee structures direct investment management behavior and influence the KPIs of funds.

Fund managers cannot guarantee returns. But they will need to receive salary even in losing months. This causes stress between the manager and investor.

The effort to reduce fee may lead to a reduction in quality of talent and regulations. This can reduce performance and increase risk management capabilities.

Performance related fee structure that pays managers only if the fund makes money is risky. This structure may lead to managers taking extra risk to avoid losses, even if the strategy does not fit the fund objectives.

A more complex fee structure can lead to better risk management outcomes. For example, we may want the manager to reduce volatility instead of pursuing alpha.

The yardstick to measure performance in investment management is complex. Do we pay managers for high returns and risk deviating from the investment objective? Or do we pay managers for mirroring a specific beta type?

In short, do we pay for better management quality or for higher earnings? It takes better managers to stick to management objectives than to seek opportunistic investments.

This is why managers are subject to complex fee structures such as risk adjusted returns and clawback schemes.

CPF payouts are not inflation hedged

Non salaried retirees face a greater risk than salaried employees in the face of inflation. At least, we assume salaries increase with inflation. Government need to help citizens mitigate the risk of 1. Inflation and 2. Longevity.

In Asia, most governments do not offer inflation protected benefits to their citizens. Given that revenues received by the state is linked to inflation, it could be the responsibility of the state to offer inflation protected schemes.

Such a scheme should have 3 core features:

1. Reasonable level of payout.

2. Payout that lasts for as long as the retiree lives

3. Payout level is inflation protected

At the moment, the CPF life meets only #2. For retirees with meagre CPF sum, payout sums can be minimal. Our payouts are also not pegged to inflation growth. To provide inflation pegged payouts, we need inflation linked annuities. To overcome the need for inflation pegged payouts, Singapore government can consider issuing bonds that are inflation indexed such as the US TIPS and Australia CAINS.

I understand that inflation indexed products can imply risks to the government. This is especially of concern when Singapore’s y-o-y inflation can range between 4 to 8%. I also note that Singapore is a small country and can be easily impacted by global demand. In the face of inflation, currency appreciation is a good way to manage risks.

Singapore should also consider financial innovation to create inflation indexed products. One way is to create a mixed basket of inflation linked products globally and hedge the currency exposure. I am not a financial expert and suspect that such intricate hedging techniques may be too costly to implement. But this could still be better than for Singapore to issue sovereign inflation indexed products. In the latter case, Singapore government would bear the entire inflation risks on behalf of citizens.