Performance fees are a divisive issue among investors with many questioning whether they are an appropriate reward for fund managers who are able to beat their benchmarks.
While the number of funds charging performance fees has dwindled in recent years, a handful of funds continue to include the charges.
Patrick Connolly, head of communications at advisory firm Chase de Vere, says performance fees are have been largely confined to funds in the absolute return sector which employ alternative investment strategies.
He said: “Investment companies will argue that performance fees align interests of investors with fund managers, but that’s not the case.
“The management fees they charge do that anyway. If a fund performs well they will earn more money as they become more popular and more people invest.”
He added: “Investment companies can justify performance fees only if they are willing to cut charges if they underperform.
“The investor takes the risk of paying extra charges and the investment company has nothing to lose, it only benefits.”
Beginning with the UK equity fund sectors – IA UK All Companies, UK Equity Income and UK Smaller Companies – FE Trustnet has looked at some of the top performers to the most recent quarter-end.
Of the eight UK equity funds carrying performance fees analysed by FE Trustnet, half were top quartile over 10 years until the end of first quarter of 2016.
Below we look at one fund from each sector over several periods.
Old Mutual UK Smaller Companies Focus
The five FE Crown-rated Old Mutual UK Smaller Companies Focus fund stands out for having been top quartile over each of the periods examined by FE Trustnet.
The fund invests at least 80 per cent of its portfolio in smaller companies, defined as those that are no larger than the largest company in the benchmark Numis Smaller Companies ex ITs index.
The £188.9m fund, which has been overseen by Nick Williamson since January 2016, has delivered top quartile performance over one, three, five and 10 years.
Its 10-year return of 262.23 per cent to the end of the last quarter end is stronger than the IA Smaller Companies sector average of 108.83 per cent.
It has also performed better than the sector average in eight of the past 10 years, only underperforming the sector in 2011 and 2009.
Performance of fund vs sector & index over 10yrs
Source: FE Analytics
According to the fund’s key investor information document (KIID), the fund charges a 10 per cent performance fee on any returns the fund achieves above the benchmark, provided any past underperformance has been recovered.
The KIID disclosed that the performance fee was 0.68 per cent in the 2016 calendar year as a percentage of the net asset value of its retail share class. The fund’s ongoing charge figure (OCF) for the year was 0.87 per cent.
Williamson took over as lead manager on the fund at the beginning of 2016 from veteran investor and FE Alpha Manager Dan Nickols.
“Instinctively we don’t like performance fees on long-only funds. They have to be very special to merit it,” said Jason Hollands, managing director of Tilney Group. “That fund has extremely strong returns, investors in that fund would not be put out that there is a performance fee structured on it.”
Adrian Lowcock, investment director at Architas, says long-only equity funds have less reason to apply performance fees than more sophisticated investment strategies.
He said: “My issue is that looking at the smaller companies they are invested in, you can get exposure without have to pay a performance fee.”
Threadneedle UK Extended Alpha
In the IA UK All Companies sector, the £123.1m Threadneedle’s UK Extended Alpha fund sticks out for performance and for its investment strategy.
The four crown-rated fund, managed by Chis Kinder since 2010, was top quartile over three, five and 10 years.
It delivered a 120.7 per cent gain over 10 years, compared with a return of 70.47 per cent for the average fund in the sector. Over five years the fund has returned 81.12 per cent ahead of the sector average of 63.14 per cent.
Performance of fund vs sector & index over 5yrs
Source: FE Analytics
However, the fund has slipped into the third quartile over one year. In the year to 31 March, the fund rose by 17.49 per cent compared with a 17.95 per cent gain for the average sector fund.
Over the past 10 years, the fund has trailed the annualised return for sector on just three occasions between 2008 and 2010.
Unlike the other funds in this article, it can take long and short positions in stocks drawing comparisons with targeted absolute return funds where performance fees are more common.
With the simple target of aiming to grow the amount invested in the fund, at least two-thirds of the assets will be in long and short positions in UK companies or those with significant operations here.
The fund has a 20 per cent performance fee on outperformance of the FTSE All Share index plus 2 per cent, according to its KIID. In the fund’s financial year to 30 April 2016, a performance fee of 1.01 per cent of the fund’s value was charged. The fund’s OCF was 0.84 per cent over the same period.
Tilney Group’s Hollands says the fund has a typical 130/30 or 150/50 structure and is more of an alternative investment strategy than other funds in the IA UK All Companies sector. He notes that profits from the fund’s short positions are redeployed into long positions.
Darius McDermott, managing director of Chelsea Financial Services, said: “It’s still a broad UK equity fund; they only take performance fees if they outperform the index rather than a cash-based target.
“Where you find most performance fees in the absolute return sector. Personally, I think some of those are a bit of spurious if you have a cash benchmark in an environment where is cash is very low, I’m not sure you should be taking them.”
JOHCM UK Equity Income
JO Hambro Capital Management stands out as one of the more active users of performance fees in the asset management industry.
Its £2.9bn JOHCM UK Equity Income fund is one of the best performers in the IA UK Equity Income sector. However, the fund is soft-closed and carries a 5 per cent initial charge for new investors, that will be off-putting for many.
Still, the fund has an impressive long-term track record and is top quartile over five and 10 years.
Managed by James Lowen and Clive Beagles, the two FE Crown-rated fund aims to generate long-term capital and income growth.
Over 10 years the fund has returned 115.63 per cent, compared with a 67.82 per cent gain for the average sector fund. In five years the fund has returned 81.63 per cent, higher than the 66.57 per cent gain for the sector average.
The three-year performance is second quartile, returning 24.37 per cent, just 1.06 percentage points above the sector’s return, having registered bottom quartile returns in 2014 and 2015.
Last year it was one of the top performers in the sector with a 16.79 per cent gain, however, as the sector returned just 8.84 per cent.
Performance of the fund vs sector & benchmark in 2016
Source: FE Analytics
As well as strong long-term performance, the UK equity income fund recorded a yield of 4.4 per cent last year, according to data from the Investment Association.
In their most recent factsheet, Lowen and Beagles noted: “We continue to find good, new investment opportunities across the market on undemanding earnings multiples and attractive dividend yields.
“These investments do not rely on what are effectively 0 per cent interest rates to deliver us a good real return.”
The fund levies a performance fee of 15 per cent on the outperformance by the NAV of the benchmark FTSE All Share Total Return index on an annual basis, according to the KIID. Any underperformance is carried forward, it notes.
Last year the performance fee amounted to 0.06 per cent. The fund’s OCF is 0.81 per cent.
“All JO Hambro Capital Management funds have performance fees, but they are structured with a low AMC [annual management charge]. They start with a low AMC first and then back themselves to outperform,” said McDermott.
Lowcock added: “My uncomfortableness with this kind of thing is: do you need performance fees for a core UK equity income funds? I wouldn’t want to see them where [a fund] doesn’t necessarily do a complicated job. It should be a core fund for an investor portfolio.”
Later in the series FE Trustnet will look at funds charging performance fees focused on the global, emerging markets and regional equities.