IFA: Risks on performance fee funds not understood

Most clients in funds operating a charging structure that includes a performance fee are likely to be inherently higher risk than alternatives in the market and this is often not communicated to end clients, according to an independent advisory firm.

In an interview with FTAdviser, Matthew Phillips, head of private clients at independent wealth manager Broadstone Pensions and Investments, argued that even when a fund ostensibly meets a given risk profile, the use of a performance fee could imply that there is greater intrinsic risk.

Mr Phillips said: “Performance fees can cause fund managers to take more risk than what they should do.

“It’s human nature: if you are a fund manager looking for return your ethos, whether we like it or not, is to... earn as much money as you can from the funds you have under management.

“You reward the manager that is going to take the performance fee for taking risk, [but] most performance fees that I have see do not have a risk metric.

“It’s all based upon outperforming this by x and do this by y and we’ll pay you this performance fee. Immediately you have skewed the portfolio.”

Mr Phillips said that one of the key issues was not the application of performance fees per se, but the fact that they are often misunderstood by clients - or that the implications of the charges are not communicated by advisers. He added, though, that the incoming Retail Distribution Review may improve this.

He said: “IFAs should be explaining it but where we are right now, I would have to say they don’t.

“Let’s face it, most private clients want a high amount of return for no risk and the bit that links up is the big change coming in the RDR. If you sell products, you sell what the clients want; that’s what an industry does. A profession gives people what they need.”

Despite Mr Phillips’ strong views on performance fees, he is not calling for a ban on them, stating that banning “is a lack of freedom”.

He said: “As soon as you get into a ban, you limit choice and there are some instances where people will want to enter into an agreement with the fund manager and set that up.

“That’s fine. I think it comes down to education. We have low levels of financial education.”