Hedge fund and mutual fund performance fees in the UK remain a convoluted area, according to a new study by Lipper FMI.
Lipper identified 81 open-ended funds in the UK with performance fees in place, up 138% from 2007, although less than 5% of the industrys total number of funds.
The findings discovered that two thirds of UK mutual funds can charge performance fees when the fund outperforms a falling index, despite the fact that investors are still losing money.
Performance fees, however you want to look at it, are going to be more complicated that having a standard management fee, says Ed Moisson, head of consulting, Lipper FMI, and author of the report.
Performance fees on open-ended funds have only been in existence in the UK since 2004, when the FSA lifted the ban. In 2007, the FSA said we do not act as a price regulator, and we do not consider it appropriate for us to take such a role in these circumstances.
According to Moisson, it seems logical that there should be a cap on performance fees: There is a limit to how much additional fee revenue can be justified based on the market you are following. For example, if you were investing in emerging markets last year, broadly the indices were going way up, there is a limit to how much of that can be attributed to the fund managers skill.
The study highlighted that the majority of funds also charge a management fee of 1.5%. If the fund has a management fee at the same level as the rest of the industry, and a performance fee on top of that, investors should be concerned because this is where you get a situation where the performance fee is all upside. The fund manager might gain additional revenue if they do well, but if they do badly, then they get what the rest of the industry getting anyway, explains Moisson.
Antonio Borges, chairman of the Hedge Fund Standards Board, recently stated in the FT: We dont care about fees; we care about after-fee performance, and anybody whose netted-fee performance is not good, we just exit and go elsewhere.
Moisson holds a different viewpoint: It was of interest to me that the Hedge Funds Standards Board goes into great detail about various areas but the performance fee sector is a bit thinner.
From my perspective, fees have a direct impact on performance.
Moisson admits that for hedge funds, sophisticated institutional investors will apply their own fee analysis, perhaps lessening the need for the HFSB to look into fees in more depth, but added that more analysis into the subject can only help increase transparency.
For retail investors, the benefit of performance fees is disputed. Peter Hargreaves, founder of Hargreaves Lansdown, recently said: “Performance fees only benefit fund-management groups. They do not benefit the client indeed the client is normally disadvantaged by them.”
The total expense ratio of hedge funds can also be confusing. According to the report: Among hedge funds where Lipper has calculated Total Expense Ratios, the asset-weighted average is 1.82% and the mean is 2.48% before the impact of performance fees, which can often double the level of annual expenses incurred. Clearer disclosure of such costs would certainly help hedge fund investors.
Unlike the US, mutual fund fees in Europe are increasing. Moisson sees the fund distribution infrastructure as a major culprit: In the UK through IFAs or in continental Europe through a bank or distribution platform, it is an intermediated market, and in order to have a successful fund, you need to be able to be distributed. To do that, you need to be paying a sufficient level of commission, and the annual distribution fee or trail commission in the UK is given as a reason by a fund management company as why their fee levels are the rate they are, or why in some cases they push their fees up.
Investors should be looking at the performance fee and the base management fee, and is that below what I would expect to pay elsewhere and if the fund fails to perform I am actually paying less than the industry? That would give added credibility to the fee structure as a whole, he concludes.
The report can be found here
Giles TurnerNews Editor