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Fees frame

Paying for performance is under increased scrutiny as fund management houses look to justify fund charges in light of steep losses felt by investors. While top-performing funds may be able to command or maintain a higher charge, the pressure on fees will be felt on those which have underperformed. With equity markets still struggling to advance significantly, this trend is likely to accelerate.

With the majority of equity-based mutual and pension funds sitting on steep losses following the disastrous 2008 period and rocky opening quarter of 2009, those vehicles that have been able to be make gains are benefiting from increased attention.

The groups that manage these may be able to better justify higher charges as a result. But the flip side of the argument is – are the fees that have been mainstays for years still worth the money? Can investors, and are they still willing to, pay 5 per cent initial and 1.5 per cent annual fees for funds that underperformed the market?

According to a March report from pension and investment consultants Watson Wyatt: “There are fault lines with the investment management value proposition in that the vast majority of investment products carry too much cost for the value they deliver.”

The same argument could be had for retail investment funds. There are relatively few actively managed funds which, after charges, can profess to outstrip a low-cost passively managed portfolio over the past 12 months.

According to Trustnet figures over 2008, the best- performing UK passive fund was ranked 65th out of 318 funds in the UK all companies sector – RBS’s FTSE 4 Good Tracker. The worst tracker was ranked 155th. This means that 64 actively managed portfolios did better than the best-performing index fund and 163 fell by more than the worst tracker. It is worth keeping in mind that the performance figures on which this analysis is based are priced bid to bid (mid to mid) and therefore do not take into account the impact of charges, meaning that the lower-costing index trackers are likely to have done even better if charges were accounted for.

Thames River Capital co-head of multi-manager Gary Potter cautions on using the past 12 months as an example of passive outperforming active management.

He says: “The characteristics of the past 12 months have been incredible and, yes, some active managers were slow to recognise the changes from the commodity boom to the financials bust quick enough but overall, good managers will outperform in the long term.”

Potter cites investing in Adrian Frost’s Artemis income fund at its launch in June 6, 2000. If £100,000 were put into the fund at launch, it would have been worth £169,966 as of March 31, 2009 on a total return basis, with £50,000 of that gain from income and the remainder from capital growth. The FTSE 100 would have turned that £100,000, with income reinvested, into £80,399.

There are funds that have done well in the volatile past 12 months that do charge higher fees than the typical 5 per cent initial and 1.5 per cent annual and it is unlikely, given their recent performance, that these will fall any time soon. According to Trustnet figures, once private client portfolios are discounted, there are fewer than 20 equity-only funds that made a gain over the 12 months ending April 2, 2009.

Two are from Neptune – the Japan opportunities and US opportunities funds, which both feature a standard 5 per cent initial charge but also feature a 1.6 per cent annual fee.

There are four health and biotech portfolios among the list of funds which achieved positive returns and, of these, two charge higher than the industry’s typical levels. Axa Framlington’s biotechnology fund is ranked 23rd out of the entire unit trust/Oeic universe over the period examined while Schroder medical discovery is ranked 119th out of 2,143. The Axa Fram portfolio features a 1.75 per cent annual fee while the Schroder vehicle charges 1.5 per cent as an AMC but has a 5.25 per cent initial charge.

Jupiter financial opportunities, ranked 54th, and SG’s core Japan alpha, ranked 127th out of the 2,143 universe of funds, also achieved positive returns and, like the Schroder medical fund, these two also have a 5.25 per cent initial charge.

But while investors are apparently getting what they pay for in these higher- charging but better-performing funds, the pressure is on for the underperformers to continue to justify their fees – even if they are in line with the industry norm.

Potter says: “I am a big believer in you get what you pay for and while I don’t think better-performing funds will put their fees up, the pressure will be on for mediocre funds to cut theirs.”

The Watson Wyatt report mirrors that prediction for the institutional world. It notes: “We believe there will be a greater awareness of costs relative to the value proposition. Funds will also be more aware of the misalignment of interests within current fee structures. The fund of the future will assume more influence over costs through negotiation and will seek a clearer value proposition from investment managers.”

Although hedge fund performance fees are certainly under pressure these days, the premise of the remuneration structure remains valid.

Potter believes there could be more of that used in the retail space in the near future as investors look to get better value for their money. Although many retail performance fee structures are currently on top of existing AMCs and initial charges, the pricing of the future could see a greater emphasis on such fees being incorporated within. He says: “We could see different structures coming out where fees reward good performance but also penalise for underperformance.”

With a wary investor already nervous to recommit to the market and with continued pricing pressure coming from platforms, fund groups will struggle to justify fees in the coming months. The past year may have been an incredibly difficult period but, with the steep losses, it is likely to lead to a resurgence of attention paid on how much investors are paying for active management and just what they get for their money.

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