Eyewatering Chrysalis performance fee throws investment trust charges in the spotlight

Chrysalis Investments’ eyewatering performance fee payout has sparked a debate on whether investment trusts should be holding onto their expensive charging structures.

The £1.2bn trust caused a stir when it was revealed managers Nick Williamson and Richard Watts raked in an unprecedented £112m in performance fees.

The fees were calculated over one year, a period in which the trust’s net asset value shot up 57% as key holdings, including Wise, Klarna and Starling Bank benefited from valuation uplifts and material funding rounds.

Calculating performance fees over such a short timeframe is controversial, according to Stifel, and out of step with most private equity fund fees which are calculated over the fund’s life and primarily reflect realised gains.

“With the current Chrysalis arrangement, there is a high risk that the management fee is high one year largely on unrealised gains,” analyst Iain Scouller wrote in a recent note.

“The following year may see a reversal in the net asset value (NAV) and price performance, with a possibility that shareholders see negative returns over a two-year period.”

Already this year Chrysalis has seen nearly 26% of its value wiped as its investments in THG and Wise have found themselves caught in the crosshairs of the January tech sell-off. Its shares now trade at a whopping 28% discount to NAV.

Stifel said it was “not surprised” the board is reviewing the trust’s performance fee arrangement.

The investment trusts charging more than Chrysalis

Including its performance fee, Chrysalis currently has an ongoing charge of 8.2%.

But it is not the most expensive investment trust on the market. Portfolio Adviser found four other closed-ended vehicles with higher charges from an array of sectors from data supplied by the Association of Investment Companies (AIC).

Aircraft leaser Amadeo Air Four Plus, the self-managed British & American trust and UK smaller companies-focused Rockwood Realisation all had higher fees, despite not charging for performance.

Only one vehicle -Pershing Square Holdings – had a performance fee arrangement in place, which boosted charges from 1.6% to 11.7%. The £7.3bn trust, founded by American investor Bill Ackman, invests predominantly in US quoted companies, such as home improvement retailer Lowes and Mexican fast food chain Chipotle.

It has produced a share price total return of 148% over three years but on a one-year view is up just 5%. However, performance fees are usually calculated based on NAV.

Specialist trusts Catco Reinsurance Opportunities, VinaCapital Vietnam Opportunities and hedge fund BH Macro are not far behind Chrysalis, with charges ranging from 7.3% to 8.1%.

Investment trusts with highest ongoing charges after performance fees

Source: Association of Investment Companies

96 investment companies still charging performance fees

Performance fee arrangements have become less prevalent in the investment trust world, as actively run funds have faced increasing competition from cheaper, passive alternatives and boards have bowed to shareholder pressure to axe them.

Since 2013, 50 closed-ended vehicles have ditched their performance fee arrangements, according to data from the AIC.

Smith & Williamson MPS co-head James Burns noted two weeks ago Henderson High Income became the last of the old guard of UK equity income trusts to ditch its performance fee.

“We’ve been very happy to see more and more performance fees going,” he says. “I think for conventional, long-only equity, it’s very hard to justify having a performance fee.”

However, excluding VCTs, 96 out of 240 investment companies or 40% still charge for performance currently. This includes a number of funds that have only launched in the last several years, including Schroders British Opportunities and Seraphim Space.

Expensive charging structures tend to crop up more frequently in specialist sectors, including private equity, biotech and alternatives, than conventional vehicles investing in quoted companies.

In the six-strong AIC Growth Capital sector, where Chrysalis sits, only two trusts do not charge a performance fee – Baillie Gifford’s Schiehallion and Petershill Partners.

It’s a similar story in the closely related AIC Private Equity sector where only a quarter of the 16 trusts do not have an extra layer of complex charges.

Performance fees stacked in favour of the manager

Fairview Investing founder and director Ben Yearsley does not have a problem with performance fees in principle. But, generally, he believes they are stacked in favour of the manager with hurdles that are far too easy to beat, meaning there is “very little incentive to outperform”.

Portfolio Adviser recently revealed Nick Train’s Lindsell Train Investment Trust bagged £14.5m in performance fees over the last decade by comparing the performance of its portfolio of global equities against a UK gilt benchmark. It has since adopted the more appropriate MSCI World index as its benchmark.

Good performance serves as a kind of performance fee already, Yearsley argues. As the net asset value of a trust goes up, so too do the fees it collects.

Scottish Mortgage, which saw assets double to £20bn in a little over a year, is a prime example of this.  With an OCF of 0.34%, it went from collecting £34m on £10bn worth of assets to £68m on £20bn.

Winterflood head of investment trust research Simon Elliott disagrees. “A well-structured performance fee can play an important role in incentivising an investment manager, particularly where prospects for issuance are more limited,” he says.

Chrysalis’ structure falls into the “badly structured school of performance fees”, Elliott adds.

“In our opinion a more equitable arrangement would be to measure performance fees over rolling periods, rather than take a 12-month snapshot, and make them subject to a cap, ie a percentage of net assets, in any given year, with excess fees carried forward.”

‘Subjective’ NAV calculations a major issue

Killik head of managed portfolio services Mick Gilligan says a major issue is where performance fees are based on NAV performance and NAV is calculated “in a subjective manner” via a single third-party valuation rather than market valuations.

“Often the market takes a view that the NAV is being valued too high and a discount develops. Investors bear the brunt of this in the form of a lower share price, but management continue to accrue performance fees based on the higher NAV,” he explains.

“The Kid has helped make performance fees more transparent, but I think it could go further on this aspect. Some of the calculations are complex and involve going back to the original prospectus and putting a cold towel around your head.”

Ashoka India Equity offers a compromise

Gilligan and Burns believe there are situations in which performance fees are acceptable. Both point to Ashoka India Equity (AIE) as an example of a trust with a progressive performance fee structure.

Gilligan notes AIE and UK equities trust Aurora levy high performance fees but do not charge any base management fee.

“Now that’s a real incentive,” he says. “It’s not for everyone as the performance carry is 33% and 30%, respectively, but it certainly aligns the managers and investors’ interests.”