While performance fees are widely accepted in the IFA community, many private investors look upon them with scorn.
A recent FE Trustnet
poll revealed that more than half of our readers automatically dismiss a fund if it charges a performance fee, regardless of its reputation or track record.
Juliet Schooling-Latter, head of research at Chelsea Financial Services, thinks cost should always be considered when putting together a portfolio, but says the obsession with charges can be counterproductive at times.
"I’d tell investors not to get too caught up about costs in general – at the end of the day, it’s the performance net of fees that matters," she explained.
"Performance fees can be looked at as a positive. If they have a high watermark and aren’t charging a fee just because they beat cash, they often align a manager’s interests in line with the investor’s."
She also highlights the fact that funds with a performance fee are often cheaper in terms of total expense ratio (TER), which she says counteracts the added costs during periods of outperformance.
Here are five top-rated portfolios that 56 per cent of our readers are missing out on:
JOHCM UK Opportunities
Like all funds under the management of JO Hambro, FE Alpha Manager John Wood’s JOHCM UK Opportunities charges a performance fee on top of its total expense ratio (TER), which currently stands at 1.31 per cent – significantly less than the average UK All Companies retail fund [1.53 per cent].
The £963m fund charges 15 per cent on any return in excess of its FTSE All Share benchmark on an annual basis.
It uses a high watermark, meaning that all underperformance from one year is carried through to the next. The manager is only paid a fee once he makes up for the underperformance from the previous year.
Performance of fund vs index since launch
Source: FE Analytics
Inclusive of all fees, the fund has returned 68 per cent since its launch in December 2005, compared with 37.06 and 28.33 per cent from its FTSE All Share benchmark and IMA UK All Companies sector average respectively.
The fund has also been significantly less volatile than both.
Wood and co-manager Ben Leyland have outperformed the All Share in four out of six calendar years.
The managers are cautiously positioned, with overweights in defensive sectors such as tobacco and healthcare. They also have a significant weighting to cash – currently at 16.5 per cent.
The fund is available for a minimum investment of £1,000 and currently has a yield of 3 per cent.
Insight Absolute Insight
Another fund headed up by an FE Alpha Manager and with five crowns, Insight Absolute Insight charges a performance fee of 10 per cent on all returns in excess of its 3 Month LIBID GBP benchmark.
Like JOHCM’s range of funds, it has a high watermark.
A recent FE Trustnet
study highlighted Reza Vishkai’s portfolio as one of the few in the Absolute Return sector to have delivered on its promises: according to FE data, it is one of only two funds that managed to at least break even every calendar year between 2008 and 2011.
Since its launch in February 2007, the fund has returned 27.7 per cent net of all fees, significantly outperforming its sector and benchmark.
Performance of fund vs sector and index since launch
Source: FE Analytics
Vishkai’s portfolio is a fettered fund of funds, meaning that it only holds portfolios run by Insight.
The performance fee is calculated across the fund in aggregate rather than individually across the underlying holdings.
As well as the performance fee, it has a TER of 1.26 per cent, which is well below average for an Absolute Return fund.
It is currently yielding 1.57 per cent.
JOHCM UK Equity Income
This £1.2bn fund has exactly the same performance fee structure as JOHCM UK Opportunities, again using the FTSE All Share as the benchmark it aims to beat.
JOHCM UK Equity Income has returned 89.9 per cent since its launch in November 2004, beating its FTSE All Share benchmark by 24.29 percentage points, albeit with more volatility.
Since inception, it has only failed to outperform its benchmark in 2007 and 2011. With a one-year historic yield of 4.6 per cent, it is yielding slightly more than the average UK Equity Income fund.
The fund is headed up by James Lowen and Clive Beagles, has a minimum investment of £1,000 and a TER of 1.32 per cent. It has four FE crowns.
Scottish Oriental Smaller Companies
Performance fees are more common among investment trusts. Among those that use them is the five crown-rated Scottish Oriental Smaller Companies investment trust, headed up by star manager Angus Tulloch.
According to data from the AIC, the trust has an ongoing charge – which is almost identical to a TER – of 1.01 per cent.
Given how successful the portfolio has been, this charge increases to 2.28 per cent when the performance fee is taken into account.
Performance of trust vs benchmark over 10-yrs
Source: FE Analytics
However, in spite of these additional costs, the trust is consistently at the top of its IT Asia Pacific ex Japan sector and is among the best performers in the entire AIC universe over three, five and 10 years.
Over the last decade, it has returned 479.69 per cent net of fees, significantly outperforming its MSCI AC Asia ex Japan benchmark, with only slightly more volatility.
The £215.8m trust is currently trading on a discount of 4.3 per cent and has a yield of 1.49 per cent.
First State was not available to comment on the exact details of the performance fee.
Murray International Trust
Bruce Stout’s portfolio is one of the most highly rated investment trusts of recent times, topping its IT Global Growth & Income sector with ease over five and 10 years, with returns of 81.08 and 357.21 per cent respectively.
Annually, the trust charges 5 per cent on the first 2 per cent of outperformance over its composite benchmark – split 60/40 between the FTSE World ex UK and FTSE World UK – and then10 per cent on any additional outperformance.
According to the AIC, this pushes the ongoing charge from 0.75 per cent to 1.16 per cent.