Mutual fund with unusual fees and objectives highlight need to be mindful of performance benchmarks
On paper, a fee scheme that would reward benchmark outperformance and punish lagging returns should be a slam dunk for investors. But even that system can be gamed, as the case of one unusual mutual fund illustrates.
The Putnam Capital Spectrum Fund was launched in 2009 as a “go-anywhere” strategy. As explained by Wall Street Journal columnist Jason Zweig, it’s able to hold a wide range of assets — U.S. and international bonds, bank loans, preferred stocks, among others — based on what its manager, David Glancy, found attractive.
While most mutual funds come with management fees set as a fixed percentage of assets, the Capital Spectrum Fund adopted a twist on performance fees found among many hedge funds.
“When a fund earns a lower return than its benchmark, the manager is required to get a negative incentive fee—meaning it must pay money into the fund,” Zweig said, describing the so-called “fulcrum fee” system that many mutual funds, including the Capital Spectrum strategy, uses.
The fulcrum fee Putnam chose to implement, however, was measured against a peculiar yardstick: a 50-50 mix of the S&P 500 and the JPMorgan Developed High Yield index, a global basket of low-rated corporate bonds. It ostensibly made sense at the time the fund was launched, as Glancy was anticipating that it would hold a grab bag of investment assets.
The fund’s class A shares’ average annual returns from May 2009 through October 2013 clocked in at 23.7%, according to Zweig, while Its blended benchmark compounded at 18% over the same period; those numbers include reinvested dividends.
But there was an undeclared asterisk: throughout its lifetime, the fund had never approached the 50% global high-yield bond allocation that its benchmark assumed. In other words, the index it was measured against was effectively handicapped to generate comparatively muted returns during the fund’s early years.
Things started to turn for the fund in 2015, a year in which its A shares lost 9%. From the beginning of 2016 up to the end of last year, they returned minus 0.2% annually; in contrast, the S&P 500 registered annual growth of 14.4%.
Over recent years, the Capital Spectrum fund has underperformed even its unique 50% benchmark. An SEC filing showed that Putnam has paid about US$5 million in fulcrum-fee rebates into the fund since 2017.
“The people involved here knew, or should have known, they were benefiting from investing in a manner drastically inconsistent with the index that was used to calculate their performance fee,” Douglas Scheidt, an adjunct law professor at Howard University who was formerly with the SEC, said of the fund.
