Funds that charge performance fees fail to deliver
Eight of out 10 UK funds that charge investors a performance fee have failed to beat the global stock market over the past three years.
In total around 12% of funds available to retail investors in Europe levy a performance fee, an additional charge on top of the usual ongoing charge figure (OCF). The charge is triggered when the fund performance exceeds certain performance benchmarks. For example a UK fund would typically benchmark itself against the FTSE All Share.
The rationale behind this kind of fee structure is that it will motivate fund managers to outperform, although critics point out that the annual fee alone should be sufficient incentive for a fund manager to beat the stock market.
Somewhat ironically a performance fee can be triggered even when losses have been made, providing that the fund has 'beaten' the benchmark.
Active versus passive
In some cases, when the fund comfortably beats the benchmark in a given year, the annual charge can add up to 5%.
But the trouble is, according to research by Architas, the vast majority of funds are not delivering premium performance.
In fact, as the research points out, most investors would have actually have fared better over the past three years backing a low-cost passive fund tracking the MSCI World index, which follows large and mid-cap equities from across 23 developed countries.
Architas tracked 121 UK funds with performance fees, which focus on a range of assets, mainly in absolute return and equity. The research found that 97 of them had failed to beat the world index.
“People think because they charge an extra fee, they deliver something additional. But that doesn't tend to be the case,” says Adrian Lowcock, investment director at Architas.
Lowcock adds it is cumbersome for DIY investors to get hold of performance fee data and how often it is being charged. He argues funds that charge a performance fee should be more transparent on when and how much they charge.
The research adds weight to the various studies carried out over the past couple of years that have shed a poor light on active funds' ability to add value.
Lower costs, with some tracker funds or exchanged traded funds (ETFs) charging less than 0.1% versus typically around 0.9% for an active fund, is a key attraction.
Simplicity is another: investors - particularly those who are younger - favour the certainty offered by a fund that will do what it says on the tin. With active funds, in contrast, investors hope the manager outperforms the index.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
Also known as index funds, tracker funds replicate the performance of a stockmarket index (such as the FTSE All Share Index) so they go up when the index goes up and down when it goes down. They can never return more than the index they track, but nor will they lose more than the index. Also, with no fund manager or expansive research and analysis to pay, tracker funds benefit from having lower charges than actively managed funds, with no initial charge and an annual charge of 0.5%.
Usually charged as a percentage of returns for performance above a specified benchmark, such as an index. The fee can range from 10% to 20% of total investment returns on a low starting benchmark such as Libor and investors could find themselves paying extra fees for merely average performance. Note that these funds do not compensate investors when the manager underperforms the benchmark.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.