Merryn's Blog

The lie behind performance fees

Performance fees don't make fund managers better, says Merryn Somerset Webb. They just make them better paid.

Regular readers will know that we aren't much in favour of performance fees paid to fund managers. We figure that management fees are paid in the expectation that the manager will do his best to preserve and grow our capital already. If he does this, why should we pay him more?

We also figure that in a world of fees based on the value of your investments, success is effectively its own reward: do well and the assets you have under management, and hence your fee take, will grow. Not everyone agrees.

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One dissenter has just sent me a piece of research from FE Trustnet that tells us that "investment trusts with performance fees have significantly outperformed those without".

In the AIC Equity Income sector, for example, "the average trust with a performance fee has made 65.35% over the past three years, while the average fund without such a fee has made just 44.71%. This corresponds to outperformance of 44%."

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There's a similar picture in the All Companies sector. To FE Trustnet, this suggests that managers who get performance fees are more incentivised than others, and that makes them do better. So, "investors who reject the charges could end up worse off".

To me it says nothing of the sort. Instead, it simply suggests that the managers of trusts that regularly outperform have used the leverage this gives them to persuade their directors to allow them to keep charging performance fees (think of the likes of Lindsell Train's Finsbury Growth & Income Trust, and James Henderson's Lowland Trust).

Those that have not regularly outperformed have ended up losing their right to a performance fee as their directors have shifted their compensation in line with market sentiment (they have been in no position to complain), and in an attempt to keep investors in.

Being in line for a performance fee doesn't make a fund manager better. It just makes him paid more in some years than in others. As one FE Trustnet reader commented: "the obvious explanation of study results is not always the correct one".

A few years ago, I didhave a think about what would make a performance fee acceptable. The post I wrote then is here:The only kind of performance fee I wouldn't mind.

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