A lot of the distrust of these charges comes from a lack of transparency. Investors are used to looking at the annual management charge (AMC) and total expense ratio (TER) to determine how expensive a fund is, but these do not include the performance fee.
In most cases, the investor has little idea of how much they’re paying until the end of the financial year, made even more complicated by the concept of “high water marks.”
However, the Association of Investment Companies (AIC) has sought to make performance fees easier to understand by including them – when appropriate – in the ongoing charges figure of portfolios.
Ongoing charges are soon to replace TERs as the standard measure of cost for a fund. As well as including all the charges in the TER, ongoing charges will also take into account the cost of investment management and administration, as well as fees for custodians, regulators and auditors.
Investment trusts already publish ongoing charges in anticipation of the change. While the figure does not include performance fees, the AIC believes investors should be made aware of their impact on cost.
“The issue of transparency is of great importance in our industry, and we think it’s good to give investors as much information as possible,” said Annabel Brodie-Smith, head of communications at the AIC.
“[The calculation] is not an exact science, but a good indicator of how much investors are paying.”
The “ongoing charge including performance fee” figure is backwards looking, calculating what an investor would have paid over the last year.
Impact of performance fees on charges
| Name | Ongoing charges (%) | Ongoing charges inc. performance fee (%) |
| IT UK Smaller Companies | 1.00 | 1.19 |
| IT Global Emeging Markets | 1.29 | 1.42 |
| IT UK Growth | 0.81 | 0.84 |
| Throgmorton Trust | 1.14 | 2.39 |
| Scottish Oriental Companies IT | 1.01 | 2.28 |
| Invesco Perpetual Select UK Equity | 1.20 | 2.17 |
Source: AIC
The table above shows the extent to which performance fees have an effect on the cost of owning a fund.
In terms of sector average, the fee goes up by only a handful of basis points, though this is still significant over the long-term. According to the AIC, the average Global Emerging Markets sector has an ongoing charge of 1.29 per cent, which rises to 1.42 per cent when the performance fee is included, for example. This is even though only half actually charge a performance fee.
In the most extreme cases, the performance fee pushes the ongoing charges figure up by a full percentage point. Angus Tulloch’s Scottish Oriental Smaller Companies trust’s ongoing charge rises from 1.01 to 2.28 per cent, while Throgmorton Trust’s charge rises from 1.14 to 2.39 per cent.
This figure could be very different next year of course, and the majority of trusts ensure that they have to make back any underperformance from a previous year before charging anything on top of the benchmark.
It is important to remember, however, that the majority of data sources – including FE Analytics – includes the impact of the performance fee when displaying performance data.
So, in spite of the extra fees entailed, the Scottish Oriental Smaller Companies IT still significantly outperformed its sector and benchmark over a one year period.
Performance of trust, sector and index over 1yr
Source: FE Analytics
There is, of course, a case for performance fees, with many pointing out that the AMC is usually much lower to compensate any extra charges.
All of the funds under the management of JO Hambro Capital Management (JOHCM) charge a performance fee, in most cases 15 per cent on anything delivered in excess of the benchmark, on an annual basis.
Gavin Rochussen, chief executive of the firm, believes performance fees get the very best out of a manager.
“The excellent results of our funds all start with the talent. We believe in finding the most talented managers and giving them the freedom to develop their ideas,” he said.
“Some may argue that a manager is going to do his best regardless of whether he’s paid [a commission], but our system definitely promotes a competitive culture, which you can see in the performance figures.”
“Performance fees attract exactly the sort of manager we want here – entrepreneurial investors who are driven by outperforming their peers.”
Performance of fund versus sector and index over 10yrs
Source: FE Analytics
He points to the success of JOHCM funds in spite of the apparent “handicap” of performance fees – particularly the UK Growth portfolio, which has the longest track record of those in the range.