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Dunham Gives Fund Managers Tough Love

In a refreshing twist, this fund company won't pay its managers unless they perform.

Hedge funds aren't the only money managers that don't get paid unless they perform.

Dunham & Associates Investment Counsel, a mutual-fund adviser based in San Diego, Calif., also puts its money where its mouth is. Managers who subadvise its funds -- including big names like Neuberger Berman and Calamos -- earn fees based on performance. If the funds fail to beat their benchmarks, the managers get nothing.

How refreshing is that? Fail to perform, walk home empty-handed.

Hedge funds, which are lightly regulated investment pools that cater to the wealthy, typically charge two kinds of fees; a base management fee of 2%, plus 20% of any profits they make for their investors.

Like hedge funds, the fees on Dunham funds never fall completely to zero, because they have other expenses to pay such as custodians, transfer agents and accountants.

But the managers themselves are paid on a sliding scale, depending on how the funds perform in relation to benchmarks. Known as fulcrum fees, they rise when a fund's alpha is higher and fall when it is lower.



Dunham Large Cap Growth Fund (DNLGX) has the smallest minimum expense ratio at 1.21%. This can jump as high as 2.21% if the fund performs well. The fund with the largest minimum expense ratio the

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Dunham International Stock Fund (DCINX), is 2.1%. And the

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Dunham Emerging Markets Stock Fund (DAEMX), which has a minimum expense ratio of 1.91%, boasts the highest fee, 2.91%, if the manager brings in big profits.

By comparison, most mutual fund managers earn a flat fee based on the percentage of assets, regardless of how much money they make or lose. That goes for both actively managed funds and those that passively track indexes.

"At the end of the day, investors want to pay for results, not attendance," says Jeffrey Dunham, chairman, chief executive and founder of parent company Dunham & Associates Investment Counsel. "The unique thing about us is 100% of our money managers were willing to bet their income stream on how well they do for shareholders."

Here's how the fulcrum fees work: If a fund's performance matches its benchmark, the manager earns the fulcrum point, which averages 0.5%. If the fund, on a rolling 12-month basis and net of all fees, beats the index by 3.0 percentage points or more, the subadviser gets a 0.5% bonus. If the manager outperforms by just 1.0 percentage point, he or she receives a third of that bonus, or about 0.16% on average.

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On the flip side, if the fund underperforms by 3.0 percentage points, the fund manager loses the entire 0.5% fulcrum point. A 2.0-percentage point underperformance would reduce the fee by to 0.32%, leaving the manager with just 0.18% in his pocket.

For example, the Dunham Large Cap Growth Fund has a fulcrum point of 0.6%. In 2007, it returned 18.3%, beating the Russell 1000 Growth index by 6.0 percentage points. Since the funds are judged on a relative basis compared to the benchmark and their peers, not on an absolute basis, this manager walked away with the maximum fee.

The top ten holdings of the Large Cap Growth Fund include


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Meanwhile the opposite can happen on the downside. The Dunham International Stock Fund earned just 0.6% last year, more than 10.0 percentage points below its benchmark, the MSCI EAFE. That manager worked for free in 2007.

However, in a down market, even if a fund falls, if it falls less than its benchmark, the manager can still walk home with the bonus fee.

Dunham also offers registered investment advisers and independent brokers who sell its funds a choice of how to get paid. They can either receive a flat distribution fee or a performance-based fee. The flat fee would be from 0% to 2% on an annual basis, or sellers could get 5% of the profits on the account paid quarterly.

Like the fulcrum management fees, the performance-based distribution fees align investment advisers compensation with that of clients, since both get paid for results.

The idea of performance fees isn't revolutionary, but it is largely confined to hedge funds and other products aimed at large investors. Dunham & Associates has been working with this structure for institutional clients since its founding in 1985. It launched 10 funds for retail customers in December 2004. These remain the only funds that can potentially pay a subadviser nothing. The San Diego firm says it is also the only firm allowed by the

Securities and Exchange Commission

to hire and fire money managers on a performance basis without a shareholder proxy.

Still, Lipper says six other fund companies run funds with some level of pay for performance, including




. Lipper tracks 223 different funds with performance-based fee structures, and they are split into 654 different share classes. Fidelity, which started this practice in the 1970s, has the most with 64 different funds. These include

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Contrafund (FCNTX),

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Magellan (FMAGX), which

reopened to new investors last week, and

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Growth Company (FDGRX).