Price of performance

4 December 2009 8:00 am

Paul Farrow Farrow’s View

Most people do not mind paying for that extra bit of quality but it it is when you do not get value for money that the complaints begin.
In recent weeks, there have been a few moans over fund charges, with critics suggesting they are too high.

In the US, the Supreme Court has been examining whether the fees charged by mutual funds are too high and, if so, whether investors should be allowed to sue the boards that approved them.

On this side of the pond, Alan Miller, the former chief investment officer at New Star, has ignited the debate about excessive fees by claiming fund managers maintained complex cost structures to hide fees that added an estimated £5.8bn to the £4.3bn annual charges explicitly reported.

Miller argues the industry’s standard measure of the operating costs - the total expense ratio - should be replaced with a calculation that includes all the costs of running a fund.

Now, popular absolute return funds are under the spotlight for their performance fees. Some advisers reckon the benchmarks on which the fees are based are too easy to beat.

Some funds charge a fee of 20 per cent on performance above the Bank of England bank rate and three-month Libor respectively.

There is no doubt that the choice of benchmark, when it comes to performance fees, is important. You only have to recall the performance fee paid to Henderson technology fund managers in 2000 to see why.

At the height of the dotcom boom, the Henderson technology team created a furore when it linked fees on the fund to the performance of the FT S&P world index. As one vocal IFA said the time: “A monkey investing in technology stocks could beat the FT S&P world index by a mile. It is just not a fair comparison.”

Henderson went on to pick up performance fees totalling about £40m in 2000.

The furore that followed was justified but having a Libor or base rate benchmark for an absolute return mandate is not in the same category.

So long as the fee structure is transparent and up front, then there should not be a problem - for the investor or for the adviser for that matter.

Besides, many absolute funds failed to beat their benchmark when rates were above the 5 per cent mark, suggesting that the performance fee will not always be a shoo-in when interest rates start to rise again.

Performance fees have a place and, if structured fairly, they should align the fund manager’s interest with that of the investor - and that is no bad thing. Indeed, if the fund is delivering the goods, I doubt that investors will not care too much either.

Questions about excessive fees should not be targeted at managers that try to deliver superior returns but should instead be directed at managers that do little more than follow a benchmark and charge extortionate fees for doing so.

Of course, investors who are unhappy with the level of charges or the performance fees awarded, can always ask themselves why they are willing to pay the higher price for sub-standard goods.

And if they are not happy, they should follow the advice of Judge Frank Easterbrook who said last year, investors could always vote “with their feet and their dollars” if they think the fees are too high.

Paul Farrow is digital personal finance editor at the Telegraph Media Group

 

 

 

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