Good performance should be rewarded and poor performance punished. It seems simple enough. But where to set the limits is another matter and how to judge what is good performance is also a debate that investment IFAs are keen to have.
A base for starting the measurement is the current annual management charge of 1.5 per cent. Much of the fund industry would probably like the AMC to rise above 1.5 per cent but most investment IFAs, such as Chelsea Financial Services managing director Darius McDermott, feel that 1.5 per cent is an adequate level.
McDermott says if fund managers want to raise the annual charge to levels such as 1.75 per cent, then there should be substantial increases in outperformance mandates.
Levels of performance fees are still a bone of contention between IFAs and fund managers. Many fund managers see it fair to reward themselves with fees of 1.75 per cent for, for example, beating the FTSE100 by 10 per cent in a quarter, IFAs such as McDermott are looking for much greater performance for such a reward, “Simply beating the FTSE100 by 10 per cent is not enough to warrant 1.75 per cent. It is too simplistic and short-termist,” he says.
McDermott says he would be happy paying such fees if the fund was first-quartile for a substantial amount of time, as well as beating the FTSE100 by such margins for at least a couple of years.
More attractive to McDermott is the idea of performance-related penalties. He says: “Fund managers should not be able to charge 1.5 per cent if they are not performing.”
He says if funds are in the third or fourth quartiles for two consecutive, discrete years, then their managers should have to reduce their fee. “If we are talking true performance-related fees, then it should swing down as well as up.”
Gartmore was one of the first firms to offer performance fees through its UK and US focus funds, launched in 2001. If the funds stay in the top quartile for 12 months, Gartmore raises its fee to 2 per cent but if they do not appear in the top quartile the fee falls to 1.25 per cent.
Under McDermott's criteria, this would seem too high for too little performance but Gartmore head of communications Vee Montebello says this has worked well for the UK fund but not so well for the US one. She says the UK fund has been well received by IFAs and has performed well. The US fund, on the other hand, has not had the same take-up and has so far not had a tremendously impressive run but Gartmore is determined to stick with it.
Montebello says: “Our focused funds aim to be consistently in the top quartile. They are meant to represent our fund managers' best ideas so if they are doing well then we should be rewarded for that success. On the other hand, we will give back to our investors by way of reduced fees if we are not performing at the level we intend.”
But on the other side of the camp, those fund houses that have so far not elected to offer performance-related fees are unimpressed with the current models.
New Star Investment Funds marketing director Rob Page says, contrary to what most commentators would have you believe, there is not a lot of demand for performance-related products from IFAs or private investors: “There has been a lot of talk about this in the press but we have not seen any strong demand from our client base,” he says.
He claims that this is because when you look at most of the fee structures worked out by other fund houses, it is questionable how useful they are to the investor.
There are as yet no accepted market norms in this area and Page believes many of the propositions will actually cost investors more than they would have without performance-related funds.
He says: “You have to look at the mindset behind why you are offering the performance fees. If all you are doing is charging an extra 50 blips for staying in the top quartile, then you are not really giving your customers any more than what most fund houses are aiming to do.”
He points out that a majority of New Star's funds have stuck in the top quartile not just for 12 months but since launch and that if New Star were to charge performance fees, all it would be doing was taking extra cash from its investors. “This is not exactly the most attractive proposition to give your clients.”
On the flip side, Page says if the intention from investors is to cover themselves from poor performance then this has a slightly negative connotation that does not show faith in initial fund selection.
Yet Page will not rule the possibility of New Star offering performance fees in the future through new products but not existing products. He says: “The idea does look very interesting in theory. We have looked at a number of ways of doing it but as yet it is not something that would be a benefit for our investors.”
The concept is here to stay, with most fund houses having examined the idea of offering performance fees and many products already in the marketplace but it seems there will be a lot more to come in the way of pricing structures and performance models.