Analysis: The future of performance fees

Analysis: The future of performance fees

Fund fee structures that include bonuses for managers when outperforming have often drawn criticism. But with renewed pressure mounting from a number of sources, could retail fund performance fees soon be a distant memory?

Recent research from multi-manager Architas shows that 80 per cent of UK-domiciled funds with performance fees had failed to outperform global stocks over three years. The results indicated investors would have been better off buying a low-cost MSCI World tracker instead of investing in most of the funds charging such fees.

Architas investment director Adrian Lowcock says often in these cases there is no alignment of interests between investors and fund manager. He says: “There is a clear lack of transparency in performance fees. Trying to find out when a performance fee has been charged and the impact it has on the overall costs to investors is difficult.”

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The idea of performance fees has always been a sensitive subject, but funds that charge them do still attract investor interest. 

Gavin Haynes, managing director at Whitechurch Securities, says that while they remain in place, they will attract criticism: “Fees are often structured to reward the fund manager handsomely when they outperform but they are still paid a standard fee when they underperform. For ourselves, it has to be a very strong offering if we are going to consider a fund that awards themselves a performance fee.”

As Investment Adviser reported earlier this year, the usefulness of performance fees from a provider perspective is also up for debate. Gam, the Switzerland-listed fund group, reported a profit warning in June, expecting a 50 per cent drop, due to a dramatic fall in performance fee revenue. 

Similarly, the concept has caught the eye of regulators, particularly since last year when a general upward trajectory in markets began turning more volatile. The fees’ attractiveness to consumers is once again being brought into question.

The FCA is in the process of compiling data it has gathered as part of its review of the UK asset management industry, looking at how fund houses deliver value for money to investors, though the preliminary results have been delayed.

Members of the European Parliament (MEPs) have also waded into the debate, with one German MEP, Sven Giegold,  reviving a campaign against performance fees and calling for a way to regulate the charges.

However, some argue that the problem with the fees may be less to do with their existence and more with the way they are implemented. Performance fees can be sensible as long as the manager is willing to take on downside fee risk too, according to Fundhouse’s managing director Rory Maguire.

“If a fund does well in year one, but by year five it has not added value, because it subsequently performed poorly, then the performance fee needs to reflect this.

“As it stands, performance fees will typically reward the manager over the shorter period of one year, but not result in these same fees being returned to clients if the excess performance becomes negated down the line,” Mr Maguire adds.