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.”
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.
Some fund groups do implement a ‘high water mark’ policy but, depending on the terms, this may not always be in the best interests of clients either.
Mr Maguire says: “If a fund manager gets paid well in good times, but still gets paid their base fee during poor times [the high water mark approach], this is not fee symmetry. Fee symmetry would be the fund manager returning fees to clients – on the same basis they withdrew them from the fund – when they underperform.”
Despite ongoing controversy around performance fees, end investors still may be unaware how much of their return gets eaten away by other manager charges.
James Calder, research director at City Asset Management, says: “The performance the client sees at the end of the day is net of fees, so you have to ask if you’re willing to pay up for that.”
Additionally, regulators may only have a limited scope over the extent to which they can intervene on charges, as the ultimate decision is that of the fund house that offers the product.
“I think there is little that the regulator can do in terms of influencing pricing, although they can ensure that performance fees are clearly stated and included in ongoing charges figures,” Mr Haynes says.
Mifid II will mean greater disclosure to this end, but it is ultimately up to advisers and investors to show asset managers if they are not willing to accept performance fees by simply not buying the funds that include them, according to Mr Maguire. He says: “On the regulatory point, this isn’t easy. In our view, clients should regulate fees by voting with their feet, rather than regulators capping them.”
“[Performance fees are] contentious because you’re paying up more to get a return that’s not guaranteed,” Mr Calder says. “At the end of the day, if people don’t want to pay the performance fee then don’t buy the fund. Just walk away.”
