Many closed-ended funds have ditched their performance fees over the last couple of years in an attempt to become more retail-friendly.
However, data from FE Analytics shows the ones that have continued to use performance fees have produced much better returns in both the UK Equity Income and UK All Companies sectors.
In the AIC UK Equity Income sector, the average trust with a performance fee has made 65.35 per cent over the past three years while the average fund without such a fee has made just 44.71 per cent. This corresponds to outperformance of 44 per cent.
Performance of portfolios over 3yrs
Source: FE Analytics
Over five years it has returned 191.46 per cent to the 142.78 per cent of the average performance fee-less fund, which corresponds to more than 34 per cent of outperformance.
In the AIC All Companies sector the story is the same. The average fund with a performance fee has returned 48.93 per cent over three years while the average fund without a fee has made 33.43 per cent.
Performance of portfolios over 3yrs
Source: FE Analytics
Over five years it has made 166.05 per cent to the 132.9 per cent of the average fund without a performance fee.
Iain Scouller, investment trust analyst at Oriel Securities, says that investors would be wrong to obsess over fees and miss the bigger picture of strategy and performance.
“You want to look at how management is incentivised, but at the end of the day people shouldn’t get obsessed with fees,” he said.
“Markets typically move up by 1 or 2 per cent a day – as they have in the past few days – so 50 or 60 basis points isn’t something to get too worried about.”
He adds that management fees can provide strong motivation for management teams, although market conditions have made it easier to outperform in recent years.
“Performance fees give managers quite a strong incentive, which is probably going to be key,” he said.
“But it does vary from year to year: we have seen trusts with performance fees that underperform for various reasons, one of which is market conditions.”
“Markets have been quite favourable over the last year or two, but if you go back to 2007 or 2008, a lot of people were struggling and were not getting their performance fees.”
Surprisingly, the results of the latest FE Trustnet poll suggest that retail investors may not be as set against performance fees as is often thought.
Of the 1104 respondents to the poll, 76 per cent said that they would rather pay a lower ongoing charges figure plus a performance fee as opposed to 24 per cent who said they would rather pay a higher flat charge.
This suggests that the average retail investor may be more favourable than the average institutional investor, when compared with the results of Winterflood’s latest survey of opinion.
The broker found that attendees to its annual conference for wealth managers were split 50/50 between those who favoured a lower base fee with a performance fee on top and those who preferred a higher base fee.
“The result was a dead heat, reflecting the difficulties that boards have in addressing this topic in negotiation with the management groups,” the broker said.
Some of the very best managers continue to charge performance fees, a fact that may have swayed the opinion of our readers.
Edinburgh Investment Trust, formerly run by FE Alpha Manager Neil Woodford and now in the hands of FE Alpha Manager Mark Barnett, still applies a performance fee.
FE Alpha Manager James Henderson’s Lowland trust still applies such a fee, as does FE Alpha Manager Nick Train’s Finsbury Growth & Income trust.
Performance of trusts vs sector over 3yrs
Source: FE Analytics
In the growth sector John Dodd and Mark Barnett are among the investors to use performance fees.
The figures for funds without a performance fee might look better in the income sector if the Diverse Income Trust, run by Gervais Williams, had a three-year track record.
The trust has made 43.78 per cent in just 12 months, more than any other fund in the sector, but would have had to have outperformed by an astonishing amount to reverse the overall trend.
It may be the case that those trusts with weaker records have felt the need to chase investors by lowering their fees while managers with exceptional records don’t need to.
Scouller says that the board’s point of view is probably more important, with the newer boards more likely to support performance fees for their managers.
“A lot depends on the composition of the board and its point of view,” he said. “Some of the longer-established trusts take the view that the manager is being paid for trying to deliver outperformance anyway, so why should he receive an extra fee?”
