"I don’t think the regulators have spent enough time looking at performance fees and judging whether funds are using appropriate measures," said Mark Dampier, head of research at Hargreaves Lansdown.
"I understand that in most cases you get what you pay for, but I’m not a fan of this system; the issue of performance fees is one of the reasons we’ve removed a lot of funds from our Wealth 150 list."
Dampier is particularly wary of recommending long-only funds that use cash plus benchmarks to decide performance fees.
"With Libor currently yielding next to nothing, products with a cash plus benchmark are going to take a big portion of an investor’s gains if the market flies," he explained.
"I wouldn’t say no to every fund that had a performance fee because there are always special cases, but the fewer people support this system, the better."
"Another problem is that performance fees don’t take inflation into account – I don’t see why I should be paying a performance fee when the fund hasn’t achieved what it has set out to do in real terms."
Dampier’s comments come in light of a recent FE Trustnet study that found Investec Enhanced Natural Resources and Investec Africa & Middle East – two funds that invest in high-Beta markets – use Libor plus 4 per cent per annum when deciding their performance fee.
If one of these funds manages to return more than this level during the course of a calendar year, 20 per cent of the remaining returns are transferred back to the firm.
For general performance, Bradley George’s £308.1m Investec Enhanced Natural Resources fund uses a composite benchmark, split 50/50 between the MSCI AC World Country Energy and MSCI AC World Materials indices. However, when it comes to calculating the performance fee, the firm has chosen to use a cash plus benchmark.
While it is impossible to calculate the effect that the performance charges have had on investors’ returns – as Investec publishes details of fund performance inclusive of all fees – it is possible to see the impact that a similar performance fee would have on representative indices.
Impact of Libor plus 4 per cent benchmark on FTSE Middle East & Africa index
| 2009 (%) |
2010 (%) |
2011 (%) |
|
| Before performance fee |
37.36 |
30.76 |
-18.49 |
| After performance fee |
32.66 |
26.76 |
-18.49 |
| Investec Middle East & Africa |
26.02 |
28.44 |
-30.39 |
Source: FE Analytics
According to FE data, if a 20 per cent performance fee on Libor plus 4 per cent was attached to the FTSE Middle East & Africa index, an investor would have missed out on 4.7 per cent of their total return in 2009, and lost 4 per cent of the total potential return in 2010. No performance fees would have been charged in 2011.
While Darius McDermott, managing director of Chelsea Financial, is not opposed to performance fees full stop, he thinks they are best applied to a long/short Absolute Return fund.
"It’s unlikely that I would ever support a long-only or long-bias fund which charges a performance fee," he said. "The Investec Enhanced Natural Resources fund isn’t a pure absolute fund; it has a long bias, and is very unlikely to be net-short."
"If investors are taking the risk on a commodities or Africa fund, I don’t see why they should be asked to pay extra."
David Aird, UK managing director of Investec, has hit back at criticism of these funds, insisting that performance fees are wholly appropriate in these cases and are in line with the interests of clients.
Tying performance fees to an equity index, he argues, would mean that the manager could claim a performance fee even if the investor lost money.
"Investors are only charged when we make them a positive return," he explained. "Though Libor is currently at historic lows – on average the rate has been at about 3 or 4 per cent – we believe an annualised return of 8 per cent is a phenomenal rate of return."
"Of course you can have a year when the fund does very well, but equally you can have a year when big losses are sustained. Since we have a high watermark, we only charge a performance fee after making back their losses from the previous year."
"If you ring our clients I think they’d say they were happy with the way the fund has performed," he added.
According to FE data, the Investec Enhanced Natural Resources fund has returned 23.18 per cent since its launch in April 2008, outperforming its benchmark by 14.85 per cent, with significantly less volatility.
Performance of fund since inception vs benchmark
Source: FE Analytics
Aird also points to the lack of appropriate benchmarks for the two funds in question.
He commented: "There is no natural benchmark for the Enhanced Natural Resources, as most tend to be mining focused. This is why we felt a composite benchmark was more appropriate. The Africa & Middle East indices tend to be skewed strongly to developed countries in the two regions, which makes them almost irrelevant."
When asked why Investec doesn’t use the composite benchmark when deciding performance fees, Aird said: "If the market falls by 20 per cent and our fund only falls by 10 per cent, I don’t think this is very reflective of our performance. Having a cash plus benchmark ensures we only charge investors when we’re in positive territory."
"In specialist areas like these, there is also the additional cost of technology and trading charges," he finished.