What Henry V teaches you about performance-related fees

published 2 November 2018

Shakespeare's Henry V follows on from the events of Henry IV, Part Two. The newly-crowned Henry V is persuaded by his advisers to invade France to pursue a dubious claim to the French crown. The French dismiss Henry as a leader, but he manages to take the town of Harfleur and wins the battle of Agincourt. This forces the French king to sue for peace, ceding control over large parts of France and marrying off his daughter Katherine to Henry. The play concludes with a reminder that the English gains would in the end be squandered.

On the eve of the battle of Agincourt, King Henry walks on his own through the English camp, disguised as "Henry Le Roy", an ordinary soldier. He meets two soldiers, Bates and Williams, who discuss the upcoming battle. Bates and Williams argue that the king isn't being honest about their chances of victory and that, while they will almost certainly end up dead if the English lose, the worst that can happen to the king is that he will be ransomed. When Henry protests that the king will refuse any ransom, they reply "when our throats are cut, he may be ransomed, and we ne'er the wiser".

Most hedge funds (and a surprising number of investment trusts and open-ended funds) allow the managers to claim a certain fraction of the fund's performance, either in absolute terms or above a certain benchmark. This is meant to align the fund managers' interests with those of investors, and encourage them to take the bold decisions that lead to outperformance. But as well as pushing up costs for the investor, performance fees create a situation where managers get a share of the upside, but don't have to bear any of the fund's losses.

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Funds with "fulcrum" fees try to correct this by rewarding outperformance with a (capped) performance-related fee and penalising poor decisions by reducing the annual management charge. Academics Edwin Elton, Martin Guber and Christopher Blake found that between 1990 and 1999, US funds with such fulcrum fees delivered better net returns than other funds. However, even then the American funds that used a fulcrum structure didn't actually do better than the index, suggesting active management still routinely underperforms.

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri