No matter how many times someone explains the concept of a performance fee to me, I have never understood how they can be justified.
Poorly received
The perception of them is not helped by the backlash against hedge funds that tended to charge exorbitant performance fees over and above any other charges, as well as the vilification of excess bonus payments that again were, and still are in many cases, difficult to justify.
The argument that “they help align the fund and the manager with investors’ interests” simply doesn’t wash.
My opening line is based on the latest research from Lipper that shows only 80 funds – or 3% of the entire UK funds universe – levy a performance fee, running counter to the trend between 2007 (34 funds) and 2010 (84).
This is thankfully a very low real number to get too hot and bothered about but where, relatively, the percentage gets alarmingly high is with absolute return funds where 47 of the 74 funds (i.e. 63.5%) in the IMA Absolute Return category have a performance fee.
It is no surprise that these absolute funds are mirroring hedge fund charging structures as well as hedge fund strategies.
So are they more justified here in terms of delivering superior performance at lower risk levels?
The answer seems to be “No”.
Higher fee, higher return?
Looking at 12-month rolling returns and the individual underlying periods and there is very little difference in returns depending on whether a performance fee was charged or not.
What does not help is that the same research also showed that only 34.8% of absolute return funds have posted positive one-year returns at least 75% of the time – a poor showing given this is their day job.
Looking at risk, using standard deviation to express volatility of returns, Lipper found that in seven of eight categories those with performance fees were more risky on average than those without.
When combined with maximum drawdown, the conclusion is “having a performance fee does not inevitably lead to greater risk”.
So having a performance fee does not add to the chance of an absolute return fund delivering a positive return over a rolling 12-month period. Having a performance fee might or might increase but it is not “inevitable”.
So what is the argument for performance fees again?
