Woodford profits highlight misalignment in ad valorem fees

Dividends since launch prompt ‘where are the customers’ yachts’ moment

Photo by Sweet Ice Cream Photography on Unsplash

The millions of pounds in fees made by Woodford Investment Management and Hargreaves Lansdown in a period when investors’ holdings in the Equity Income fund fell upwards of 20% has highlighted the misalignment in incentives between the industry and clients in ad valorem fees, which reward asset gathering over performance.

Woodford Investment Management made £41.7m in profits in the financial year ended March 2018, a period when the Equity Income fund fell 13.5%. Of those profits, a dividend of £36.5m was paid to Woodford Capital, which is 65% owned by Woodford and 35% by chief executive Craig Newman.

The duo have paid themselves approximately £100m total in the four financial years since the company launched, according to Companies House.

“Performance has been pretty horrific, certainly over the last two and half years, and investors have seen Woodford and his business partner take out tens of millions of dividends, while investors have been losing money,” says Candid Financial Advice director Justin Modray.

The Equity Income fund lost investors 21.2% over the last three years, according to Trustnet.

“Ultimately that’s where it would be much fairer for investors in terms of aligning interest if managers worked predominantly on a performance-related fee.”

Modray acknowledges Woodford’s all-in OCF is simpler and cheaper than many rival asset managers at a fixed price of 0.65% for the Z share class.

Hargreaves fees also under the spotlight

Woodford is not alone in profiting as investors lost money.

Hargreaves Lansdown, which has championed Woodford via the Wealth 50, enjoyed a margin of 41 basis points on funds in 2018 contributing £198m to net revenues.

Hargreaves Lansdown has previously used the fund discounts on its Wealth 50 constituents to justify its higher platform fees, which start at 0.45% and for pots larger than £250,000.

Fundsmith manager Terry Smith is among the notable absences from the recommended funds list, while Liontrust Special Situations manager Anthony Cross was dropped in the Wealth 50 revamp this year. Neither fund house offers Hargreaves discounted fees.

Meanwhile, Woodford’s two open-ended funds, which Hargreaves clients can access for a discounted price of 0.5%, both featured on the recommended funds list, only getting knocked off when the Equity Income fund suspended. In January, Hargreaves head of research Mark Dampier described the criticism he had faced for consistently backing Woodford in the face of poor performance as a “hassle”.

Dampier cashed in £5.6m of Hargreaves shares weeks before Woodford gated his fund to redemptions.

UK Shareholders Association policy director Peter Parry said it was nothing new for the investment industry to reap returns as its clients suffer poor returns. Fred Schwed’s examination of Wall Street fees in Where are the customers’ yachts? was published in 1940, Parry points out.

He says: “Woodford has made an awful amount of money out of this and so has Hargreaves Lansdown, and it’s always the customers who end up losing out in these sorts of situations. The providers and intermediaries make sure they’re always going to make something. It’s the old story of other people’s money.”

Performance fees have been structured poorly

Performance fees have traditionally had their own structural flaws, says Modray.

“We’ve seen some performance fees in the past but they’re very much geared in the manager’s rather than the investor’s interests. Typically, the manager charges what they would have charged anyway, say 0.75%, but they’ve also taken a certain cut over performance above a certain level.”

He’d like to see an asset manager make the jump and slash their annual management fee from 0.75% to 0.25% with a fee that could get them back to 0.75% “and maybe beyond” if they perform well.

“But they’ve had it easy for so long. If you’re sitting there collecting 0.75% of billions of pounds of assets it would be a massive commercial risk for them to slash that fee and then get back to where they were via performance, given performance can be quite fickle.”

“It would be great to see a group have the guts in their fund managers to be able to do that but I think for most it would be a jump too far.”

However, Orbis Investments director Dan Brocklebank is more optimistic, pointing to the fact trackers are already placing fund fees under pressure and asset managers will be required by the Financial Conduct Authority to product value for money assessments on funds from September this year.

Orbis and Fidelity innovate on fees

Orbis Investments runs a “refundable reserve fee” as an alternative to the ad valorem fee model and last year reimbursed investors when it underperformed the benchmark effectively creating a negative fee.

“When you’re different to the benchmark, you are going to have periods when you underperform,” says Brocklebank.

“We had one of those periods last year but with our model, what it meant was that our fees were negative. The experience of the clients is actually softened because the fees are negative. We hope that will help investors to stay invested throughout the cycle.”

There is a structural misalignment of interests when fund managers charge ad valorem, says Brocklebank. “The fact the clients take on all the fee risk is one of the reasons why people say that our industry’s fee structure is akin to a ‘heads we win, tails you lose’ proposition.”

Fidelity Investments revealed a fulcrum fee in 2017 with the baseline fee set at 0.65% with that charge sliding up or down by a maximum 0.20% based on performance. However, Modray says he would have liked to have seen a more significant drop in the baseline fees.

Association of Investment Companies communications director Annabel Brodie-Smith adds the fund structure can affect incentives. “The board of an investment company is not incentivised to gather assets due to the closed-ended structure but every buyer in an open-ended fund means more management fee for the asset manager so it is incentivised to grow the fund.”

The Woodford Patient Capital Trust currently does not take an annual management fee instead charging based on performance threshold, which has not yet been met. The OCF for the investment trust is 0.18%.

‘Ludicrous’ for platforms to charge percentage fee

Asset managers aren’t the only part of the investment industry to offer ad valorem alternatives with Interactive Investor, a rival platform to Hargreaves Lansdown, offering a flat fee structure.

“It is ludicrous to charge a customer based on their wealth – it takes the same amount of administration whatever the level of assets, says II head of personal finance Moira O’Neill. “For the same reason, we don’t believe in percentage fees at instrument level – it has no bearing on how we administer their assets, and it is of absolutely no consequence to us what fund, trust or equity a customer buys.”

O’Neill said there needs to be more education on the issue so investors can weigh up the pros and cons.

Although II is fee agnostic when it comes to fund structures, Brodie-Smith notes many platforms charge a fixed fee for investment trusts and percentage fees for open-ended products, notes Brodie-Smith. “Again, these platforms are incentivised to grow their open-ended business due to the pricing differential rather than the investment company business.”

In March, Portfolio Adviser highlighted the fee margin on investment trusts at Hargreaves is 32 basis points, over a fifth lower than open-ended products. Dampier argued at the time investment trusts were excluded from the Wealth 50 due to liquidity concerns, not because they are less profitable.

Ad valorem only a problem when things go wrong

Several people in the industry highlighted that ad valorem fees are only deemed a problem when performance turns sour.

Gbi2 managing director Graham Bentley says from launch to mid-2016, Woodford Equity Income beat the index by a “very significant” 25%. “The principle of ad valorem can thus far be said to have aligned fund managers, advisers, who also generally charge ad valorem fees, platforms and customers’ interests,” Bentley says.

Funds with percentage charges take in reduced revenues as a fund falls in value, he says.

Woodford Investment Management is likely to reveal reduced revenues and profits when its financial accounts for the 2018/19 year and the current financial year are published with its AUM falling from £16bn at the end of the previous reporting period.

The fund suspension, which took place in the 2019/20 financial year, is certainly going to reinvigorate the debate around costs, charges and value, says Lang Cat director Mike Barrett, adding: “Ultimately costs are only an issue in the absence of value”.

“If we’d had this conversation two weeks ago about Hargreaves, I would have said every customer would think they’re fair value for money because they’re getting great service and are very easy to use. I suspect that’s probably still the case for the majority of Hargreaves customers and particularly the ones who are not invested in Woodford.”

Tags: | | | | | |

Recent News

Leave a Reply