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.