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Fees give platform for performance

When JO Hambro Capital Management launched into the retail market in November last year, it decided to stick its neck out.

Noting that only one in five funds have had the same manager for more than five years, it made a pledge to hold on to its managers by keeping them fully motivated.

Furthermore, based on its belief that a manager can only ever be truly motivated if his livelihood is tied up in the money he runs, it decided it would base its business model around performance fees.

If its managers do not beat their benchmark, they do not get paid. If they consistently outperform, they have the chance to get very rich.

By opting for the performance-fee model, JOHCM came up against the same frustration as every investment house before it and was not able to set up a UK-based fund as such fees are currently against UK regulations.

It was faced with either launching a closed-end product or going offshore – both of which would limit the product&#39s appeal in the UK market.

In the end, JOHCM chose to launch a Dublin-based Oeic – a vehicle which does not differ dramatically from a UK-based Oeic but nevertheless has never managed to compete in popularity with investors or their advisers.

Its next step, which it is looking at for later in the year, is to launch an Isa wrapper for its funds, as well as possibly adding them to some of the fund supermarkets.

This will place them more within the average IFA&#39s radar and will bring performance-related fees to the mainstream retail market. JOHCM will not be the first firm to have brought performance fees to the open-ended market but they are still very rare.

Gartmore led the way with a new breed of performance-related charges with its focus fund range last year.

These get round the regulations by rebating part of the annual management fee in the case of underperformance. The standard annual management fee is 2 per cent – 0.5 per cent higher than the typical actively managed fund fee – but 0.75 per cent is rebated if the fund falls outside the top quartile in its sector over a 12-month period.

JOHCM argue that this is the wrong way round, and that managers should be rewarded for good performance rather than penalised for bad. For the moment, however, this is the only way of using performance fees in an open-ended UK vehicle. JOHCM&#39s best hope now lies in the possibility that UK regulations may be changed – allowing them to bring their structure onshore. The Investment Management Association says it has raised the issue on a number of occasions with the FSA but as yet to no avail.

More important than the enthusiasm of the fund management industry itself, it would seem IFAs too are generally in support of performance-related fees, with most saying their clients have no problem paying for better returns.

Research conducted for Money Marketing last summer, by investment selection service SHOUTS, revealed that funds with higher annual management charges tend to outperform those with lower charges. Part of this must be to do with the higher remuneration and better resources which the manager receives.

However, performance fees need not necessarily mean higher charges. For managers performing poorly, they would mean lower charges.

Simpsons partner Andrew Merricks says he would support more performance-related fees but points out that managers should only be rewarded for real outperformance. He says: “It is a bit like saying, would you pay British Rail more to make sure the trains are on time. You have got to remember that they have got a job to do – so performance fees should only reward excellence.

“I think most investors would be fairly supportive of performance fees. I support anything which increases managers&#39 motivation.”

Hargreaves Lansdown investment manager Ben Yearsley says he is a supporter of performance fees but, like Merricks, questions whether fund managers are taking too much for underperformance.

JOHCM charges a set annual management charge of 1.25 per cent, with the performance fee on top of that. While this is 0.25 per cent less than the typical 1.5 per cent charge, Yearsley believes this is not enough.

He says: “I am all in favour of performance fees as long as the fund manager is suitably penalised if the fund underperforms, just as he would be well remunerated if it outperforms. If you think that the average annual management charge is around 1.25 to 1.5 per cent, then I think you need to receive a lot less than that if you perform poorly.

The widespread use of performance fees may yet be some way off. However, the determination of firms like JOHCM may well see the FSA at least begin to consider a change in the rules.

As pressure increases on firms to reduce charges, performance fees may eventually provide a compromise – allowing managers to offer low nominal fees, but still be adequately rewarded for outperformance.


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