GPIF Working paper

GPIF’s New Performance-Based Fee Structure
2018.06.11
Takashi Jimba1

EXECTIVE SUMMARYIn GPIF, about 20% of all assets are actively managed by the asset managers, but only a small number offunds achieve the target excess return rate during the three years from FY2014 to 2016.



In addition to the problem of the selection ability of the GPIF, there is a possibility that the target excess
return rate may not be set properly by the asset managers and they focus on the increase of the asset
under management beyond their capacity.



For this reason, we revised the current fixed fee structure and partial performance-based fee structure,and introduced the following new performance-based fee structure.
① In order to strengthen alignment of interest, the base fee rate is lowered to the rate of passive fund, andthe maximum fee rate is scrapped.
② Introduction of a carryover which partially accumulates payment of annual performance-based fees so
as to link with mid- to long-term investment results.
③ A multi-year contract is concluded to enable to achieve excess return in medium- to long-term goal.



GPIF has a high reliance on passive fund as a universal owner. Passive fund is based on an efficient
market, and active fund is indispensable for the market to be efficient. We hope that introducing this new
performance-based fee structure will lead to further evolution of active management institutions.

INDEX
Issue ························································································································ 3
The new performance-based fee structure ············································································ 5(1) Base fee and performance-based fees ················5(2) Carryovers ················································6(3) Multi-year contracts ·····································6
Background ················································································································· 7(1) Current performance-based fee structure ············7(2) Extension of upper and lower limits ·················· 7(3) Scrapping of upper limit and adjustment of share of alpha based on Information Ratio 8(4) Fixing the share of alpha ······························· 9(5) High watermarks, clawbacks, and carryovers ·······9(6) Three-year average of excess returns and fixed-rate payment from cumulative carryover··································································9(7) Determination of base fee rate ······················· 10

1The opinion part of this paper is the personal opinion of the author.

1(8) Multi-year contracts ··································· 10
Conclusion ················································································································ 122

GPIF’s New Performance-Based Fee Structure
Issue
Of GPIF’s 160 trillion yen worth of assets, approximately 20 percent of traditional assets are actively
managed by institutions under asset management contracts. However, their performance leaves much to be
desired. Figure 1 shows during the three-year period FY2014-2016, only few funds outperformed theirtargets.
Figure 1: Target and Realized Alpha of GPIF Funds

8%
Realized
Alpha (past3years, perannum)

6%
4%
2%
0%
0%

2%

-2%

4%

6%

8%

Target Alpha

There are several possible reasons for this. One could bewhen database survival bias is taken into account, that is athat markets are adequately efficient, and that the potential

higher proportion than the proportion of GPIF funds hitting

for active management to prove successful is limited.

their targets. GPIF itself recognizes that has room to

According to analysis by Sykes and Dell [2017], the average

improve its selection abilities, and is working hard on

excesscontinuously to increase sophistication in this area.

return

years

in

the

universe

was

1.1

Shifting the perspective to causes on the side of the asset

percent2, but given that around three-quarters of GPIF funds

managers, the first thing to consider is that the target excess

are earning excess returns, as shown in Figure 1, there

return rates set by each asset manager are inappropriate.

would still seem to be room to exploit market inefficiencies.

Second, it may be the case that as a result of business-related

Another possible reason is that GPIF is a poor selector of

demands, asset managers may be more focused on

asset managers. Again, Sykes and Dell [2017] found that 26

increasing the balance of their assets under management

percent of funds did better than the average target excess

than on strictly controlling their management capacity andreturn of 2.7 percent during the past ten years 3, and evenpursuing excess returns.

advanced-country

2
3

duringglobalthepastlarge-capten

Average for the ten years to June 2017 for funds registered with MercerInsight.
Based on data for the ten years to December 2016 for funds registered with MercerInsight.

3

GPIF’s New Performance-Based Fee Structure
Under the current

fixed-feestructureand partial

performance-based fee structure, asset managers are paid
considerable

sums

regardless

of

their

investment

performance. They therefore have little incentive to set
target excess return rates appropriately, to be innovative inseeking excess returns, and to control their management
capacity, so a resolution of this issue was regarded as being
far off 4 . In response to this problem, GPIF decided to
introduce a new performance-based fee structure as a meansof stepping up its efforts to earn excess returns.

4

According to Ross and Turner [1999], even with fixed fees, the interests of investors and asset managers are su pposed to be aligned, but theimportance of capacity management tends to be neglected, so fixed fees cannot be supported.

4

GPIF’s New Performance-Based Fee Structure
The new performance-based fee structure
GPIF’s introduction of the new performance-based fee structure involves the following three initiatives:
 In light of the issues discussed above, and with the aim of strengthening alignment of interest between
GPIF and asset managers, the base fee rate will be decreased and the maximum fee rate will bescrapped in order to better link performance with fees.
 However, a carryover mechanism will be included to even out the amounts of fees paid. Under thismechanism, a portion of the fees will be held back in order to ensure that the amount of fees is linked
with medium- to long-term investment performance.
 Furthermore, in order to enable asset managers to achieve target excess returns over the medium tolong term, the introduction of this performance-based fee structure will normally involve theconclusion of multi-year contracts (commitments) with asset managers.

(1) Base fee and performance-based fees
The amount of fees will comprise the base fee and theperformance-based fees. The basic fee rate has been drasticallyreduced to the rate of passive fund for institutional separate

Figure 2:
Payoffs under new Performance-Based Fee Structure
Figure2：Payoffs under new Performance-Based Fee System
0.4%

account. The performance-based fees are based on the precise

Fee Ratemeasurement of the monetary contribution of investment
0.3%

performance. This is achieved by multiplying the excess return
Break-even Fee Rate

0.2%

rate on the portion in excess of the basic fee rate by the share ofalpha and the average daily balance. Moreover, there is no cap on

0.1%

the fee rate. The share of alpha is computed based on the target
excess return rate and the fee rate paid when the target excess

Share of AlphaBa s e Fee Rate

Ta rget Excess Return
Ra te

0.0%
-1%

0%

1%

2%

3%

4%

Excess Return

return rate under the current contract is reached 5. The payoff
under the new performance-based fee structure is shown in
Figure 2.

5

Value-sharing rate ＝Break−even fee rate − base fee rate
Target excess return rate−base fee rate

The break-even fee rate is the fee rate paid when the target excess return rate is achieved under the current contract.

5

GPIF’s New Performance-Based Fee Structure(2) Carryovers(3) Multi-year contracts

The full amount of the performance-based fees calculatedIn

conjunction

with

the

launch

of

this

new

each year will not be paid. Instead, 45 percent of theperformance-based fee structure, multi-year contracts are to

cumulative amount will be paid to the asset manager, withbe concluded with certain asset managers thereby ensuring a

the remaining 55 percent to be deferred to the following year
as a carryover. This mechanism is illustrated

long-term commitment.

in Figure 3.

Figure 3: Carryover Mechanism

6

GPIF’s New Performance-Based Fee Structure
Background
According to Senic [2011], when putting together a performance-based fee structure, three elements areimportant: (1) fairness toward investors, (2) positive incentives for portfolio managers, and (3) practicability
in administration. During the selection process, numerous proposals were examined with these elements inmind until a final proposal was agreed upon. The process that led to this final proposal is described below:(1) Current performance-based fee structure
GPIF

has

actually

been

implementingapartialFigure 4: Payoffs under Current Performance-Based Fee

performance-based fee structure since 2013. Under this structure,
which is described as a “vertical bull call spread” structure, there
are maximum and minimum fee rates. In exchange for the asset
owner guaranteeing a minimum fee rate, the asset manager
accepts an upper limit on the fee rate. This ensures fairness tosome degree, and prevents the asset manager from taking on
excessive risk. Despite these apparent advantages, in practice thegap between the upper and lower limits is narrow, so it is not allthat different from a fixed-fee scheme. As a result, asset
managers have little incentive to earn excess returns or control
capacity. The problem was that because fees are calculated using
the average excess return rate during the past three years andbased on the average monthly balance during the fiscal year, thecalculation of fees is not based on the degree of contribution inmonetary terms of the asset manager.

Figure 5: Extension of Upper and Lower Limits(2) Extension of upper and lower limits
With the aim of strengthening the link between investment
performance and fees, and thereby increase incentives for asset
managers,

extending the upper andlower limits

while

maintaining the current structure was initially considered as an
option. However, because there

7

GPIF’s New Performance-Based Fee Structure
would still be a maximum, this would be something of a
halfway measure. Furthermore, extending the minimumThis method is focused on efficiency in the utilization of

could result in the misunderstanding that performance-based

risk, and while it was fair to some degree, given the size offees could still be paid even with excess returns in negative

GPIF, which has assets worth 160 trillion yen, there are

territory.

limits to the use of active management, and considering thatan investment structure centered on passive investment to(3) Scrapping of upper limit and adjustment ofshare of alpha based on Information Ratio

the same degree as now would be maintained in the future,
giving incentives that serve to encourage risk taking could

The next thing to be considered as a means of providing
more incentives to asset managers was scrapping the upper
limit and using the Information Ratio 6

to adjust the share ofalpha. In other words, as can be seen from Figure 6, funds

be expected to strengthen GPIF as a whole’s efforts toachieve excess returns. Because of this, an excessive focus
on Information Ratio was not regarded as being necessary,and it was concluded that this proposal was inappropriate.

with a higher Information Ratio would have a higher shareof alpha with this method.
Figure 6:
Scrapping of Upper Limit (Information Ratio considered)

6

Information Ratio is the ratio of excess return/active risk. It means the risk-return efficiency of asset manager because active risk is thestandard deviation of excess return.

8

GPIF’s New Performance-Based Fee Structurewith high watermarks, though, is that they result in(4) Fixing the share of alphaexcessive fees being paid in the event of strong investment
The next method to be considered was to scrap the
maximum fee rate and set the same share of alpha for all

performance to begin with followed by poor performance
subsequently. Clawbacks, meanwhile, expose an asset

asset managers. This approach could be expected to offer amanager that has received fees to the risk of having to pay
high degree of fairness to both GPIF and asset managers, butthem back to GPIF. This often means that although the fees
depending on the share of alpha set, there was a danger thatcannot be recognized as revenue for accounting purposes,
it would be misunderstood as being aimed at reducing thethey are treated as income for tax purposes, so tax will needtotal amount of asset management fees paid.
Because of this, it was decided to adopt the formula forto be paid on them. It therefore became evident that

calculating the share of alpha presented in 2. (1). In otherclawbacks financially disadvantage asset managers. In lightwords, the current fixed fee rate or the break-even fee rateof this issue, the view taken was that a carryover structure,for performance-based fees would provide the basis for thewhereby GPIF withholds a portion of fees and pays thedetermination of the share of alpha 7. This would respect theremainder to the asset manager, would have the same effectterms of previous contracts and help ensure practicability inas, and be superior to clawbacks 11.

administration. In addition, if the target excess return rate
were achieved, the same level of fees as in the past would beguaranteed, so GPIF sent a clear message that the goal of the(6) Three-year average of excess returns andfixed-rate payment from cumulative carryoverchange in the structure is not to reduce the total amount of
The excess return rate forms the basis of payments, andmanagement fees paid.

we thought that the average for the previous three years(5) High
carryovers

watermarks,

clawbacks,

andshould be used. However, some asset managers pointed outthat accumulating performance-based fees as a carryover

In the case of performance-based fees with the maximum

and paying a fixed percentage (45%) of this cumulative

scrapped, it is vital to take steps to reduce the problem ofamount would have a similar effect. Unlike the three-year

excessive payment resulting from the call-option-like nature

average structure, this fixed-rate payment method could takeof the fees 8. Initially, therefore, mechanisms such as highinto account positive and negative excess returns over a longwatermarks 9 and clawbacks 10 were considered. A problem

7

According to Sykes and Dell [2017], share of alpha between 5 and 25 percent is appropriate. Furthermore, Hodgson [2017] state s that if thebase fee is 0 percent, 33 percent share of alpha is appropriate.
8
Payoff of performance-based fee shown in Figure2 is similar to call option. If this structure is applied annually, positive excess returnresults in positive performance-based fee but negative performance-based fee does not accrue in case of negative excess return. Therefore,
positive accumulated performance-based fee may occur in spite of negative accumulated excess return. This is the overpayment problem due
to optionality
9
High watermark is the fee payment structure used for the purpose of alignment of interest between asset owner and asset manager in hedge
funds. Performance-based fees are paid based on the excess return in excess of past highest accumulated excess return in this structure.
10
Clawback is the fee payment structure used for the purpose of alignment of interest between asset owner and asset manager in private

9

GPIF’s New Performance-Based Fee Structure
period of time (in the case of the three-year average

In normal market, the prices of goods and services are

structure, once three years have passed the figures no longer

determined based on supply and demand, which reflects theinfluence the calculation). Moreover, the calculations arevalue of the good or service concerned. Given that the cost

simpler to perform than with the three-year average
structure. For these reasons, it was determined that thestructure of the supplier is only directly reflected in the pricein the case of things like public utilities, and high fixed cost

fixed-rate structure would offer a high degree of fairness fordue to high salary experts like fund managers or analysts is
GPIF and would be very easy to implement in practice, andmeaningless for clients unless excess return is obtained,thisthe decision was therefore made to adopt it.
method for determining the base fee rate would seem to be(7) Determination of base fee rate
Under the current performance-based fee structure, the gap
between the upper and lower limits is narrow, so the base fee
rate is considerably high, as it factors in personnel and othercosts associated with active management as a management

fair. In the world of asset management, however, this change
in approach may be interpreted as marking an intellectual
transformation which requires fundamental changes in the
management style of asset managers.

(8) Multi-year contracts

expense. However, GPIF is basically able to meet its
During discussions on the low rate of achievement ofinvestment targets for pension funding through passive
target excess return rates, many asset managers voiced the
management alone, so active management only needs to beopinion that an impediment to the achievement of target
engaged in when excess returns are certain. Because of this,excess return rates is the fact that asset owners often cancel
GPIF is extremely reluctant to pay large fees for active
their contracts before results emerge, giving short-term poor
management that produces poor results. So it was felt that
performance as the reason. GPIF also came to the conclusion
the base fee rate should be set at the level for passivethat in its revamp of the performance-based fee structure, if
management, which is an alternative method available toasset managers are going to be under pressure to deliver
GPIF, regardless of the cost structure of the asset manager.
good investment performance, it would also be in GPIFs
However, that level is extremely low, partly because theinterests to enable them to meet their target excess returns
amount of GPIF assets that are passively managed is soover the medium to long term, and that it would therefore be
huge. The decision was therefore made to adopt the level for
appropriate to commit to lengthy contract periods. In thepassive management for institutional investors such ascase of alternative assets, commitment to long contract
pension funds, with information on this level having been
periods is commonplace, but with traditional assets,
provided by consultants.
contracts normally allow for the free exercise of the right toequities. In this structure, asset manager refunds part of performance-based fees already received if accumulated excess return is negative
after a certain investment period.
11
Hodgson [2017] states that if there is a problem with clawbacks, a reasonable alternative might be to keep back 50 percent of fees(carryover).

10

GPIF’s New Performance-Based Fee Structure

cancel, so such a scheme is unprecedented. Nevertheless, thedecision was made to conclude such contracts with certain
asset managers, and the assumption is that contracts newly
concluded in the future with other asset managers will also
be multi-year.

11

GPIF’s New Performance-Based Fee Structure
Conclusion

Issuesremainwith

theintroduction

of

this

Not only that, but as a universal owner, GPIF is heavily

performance-based fee structure. For example, how todependent on passive management, and to improve

determine the share of alpha when new contracts are

passive-management performance, efficient capital markets

concluded. GPIF therefore intends to continue working on

are a prerequisite. Active management involves day-to-day

these issues.

effort to improve market efficiency, and is therefore also

The introduction of this new performance-based fee

vital for GPIF. For its part, GPIF is confident that if thestructure came about as a consequence of factors specific tointroduction of this structure can serve as an opportunity for

GPIF, namely the need to step up action to secure excess

increasing the sophistication of the asset management sector,

returns, but given the role of GPIF and the amount of assets

particularly of active managers, it will substantially benefit

it controls, GPIF fully appreciates that the new structure willboth GPIF and its beneficiaries.

have a big impact on the asset management sector as a

Duringtheprocessofdeciding

on

this

new

whole. Due to legal restrictions, GPIF has to outsource mostperformance-based fee structure, GPIF received valuableof its asset management, and it is by no means an

insights from numerous asset managers and consultants, andoverstatement to say that the presence of robust asset

would like to take this opportunity to express its gratitude

managers that are committed to investment performance isfor that.

vital for the survival of GPIF’s operations.

＜reference＞
1.

Nick Sykes and Richard Dell [2017] “Investment Management Fees - Seeking Fairness and Alignment”, Research
Perspectives Vol.6; No.1/5, 25 September

2.

2017, Mercer

Leola B. Ross and Andrew L. Turner [1999] “Incentive Fees: Have Our Fears Been Unfounded?”, Russell ResearchCommentary, September 1999

3.

Dimitri A. Senic, CFA [2011] “Practical Issues with Performance-Based Fees”, CFA Institute Conference Proceedings
Quarterly, March 2011

4.

Tim Hodgson [2017] “An Alternative Approach to Asset Manager Fees - Fees get another rethink-”, October 18, 2017,
Thinking Ahead Institute, Willis Towers Watson

12