I admit to a degree of naivety when performance fees, particularly on absolute return funds, began to appear a few years ago. Not that I was ever keen on them. Investors paid more for what was previously available for less, and rather than aligning the interests of investors and fund managers, I felt they were lining the pockets of fund managers. Part of me hoped performance would be so good the fee would be a secondary consideration. In this respect I was, with hindsight, naïve.
A few years down the line the structure of performance fees looks worse. In part this is owing to a change in the economic environment. When they first appeared interest rates were considerably higher and Libor provided a reasonable hurdle to beat. Today this hurdle is pathetically small, while some fund managers don’t even set a hurdle to beat. Founder unit holders, who have remained faithful over the long term, are in an unfavourable position compared to new investors.
Consider the Cazenove UK Absolute Target Fund. I use this as an example partly because it remains in my own portfolio (for the moment). The fund launched in July 2008 at 100 pence per unit with the aim of generating an 8%-10 per cent return per year. To be fair, one could earn about 5% on cash at the time, which helps when a fund holds a lot of cash against short positions. Today this is not so.
Tim Russell, the fund’s original manager, did himself no favours by shorting commodities companies and being long defensives. In a commodity boom, this just didn’t work. The unit price fell to approximately 92p. Today, Steve Cordell runs the fund following Tim Russell’s departure in June 2011. The price has “recovered” to around 109p and in doing so has exceeded the previous high watermark of 108.61p. To those who bought near the 92p low, no performance fee was due until the high water mark was breached, allowing for a gain of up to around 18 per cent.
However, for long-term investors who have been in the fund from the beginning a performance fee is once again accruing, but at a price of 109p the fund has not performed. After four years I would conservatively expect the price to be at least 130p. Just to have kept pace with retail price index inflation the unit price would have to be around 112p today. As it stands investors could pay a performance fee for receiving a negative real return.
Cazenove are by no means the only offenders. It is a similar story with Liontrust European Absolute Return and Jupiter Absolute Return, among others. I cannot see how any fund group can defend a charging structure where long-term investors are penalised. Performance fee structures need to be revised and I call on all fund groups to re-examine their position. Why not be the first to make a stand and genuinely align the interests of the investor and fund manager, or better still in favour of the investor. It is not as if I have met a poor fund manager yet.
Mark Dampier is head of research at Hargreaves Lansdown