Performance fees could include five-year time horizons rather than the standard shorter time frames, according to Mercer principal and research manager David Scobie.
"The current performance fee model is one to two years. This makes it hard to measure a manager's outperformance as it could be attributed to luck, not skill," Scobie, who presented his ideas on a performance fee model at a Mercer investment conference this week, said.
"Managers generally seek, and rightly so, to be judged over a full market cycle as that is the period over which skill can materialise."
The focus on fees should be on the design of the performance fee structure and realistic performance periods to ensure managers were rewarded for actual skill, he said.
He said a performance fee model for an equity fund could include fees of 40 basis points in year one, regardless of performance.
If within two years the manager achieved the targeted performance, then a fee of up to 50 basis points would be paid.
Managers could then have the potential to earn 60 basis points in year three, 70 basis points in year four and in year five, where it plateaus, 80 basis points if the alpha target is met.
"It is binary, so if the alpha [level of outperformance versus the benchmarks] targets aren't achieved over the relevant periods, then the fee defaults to 40 basis points," Scobie said.
"Investment mandates typically include a three-year time horizon. This particular model allows performance to be measured over time and is consistent with what a manager is trying to achieve."
He said the performance model was only conceptual and not part of Mercer's investment policy.
