Active vs passive: fund performance fee model no help to transparency

The FCA’s Final Report from its Asset Management Market Study published in January 2018 set out its proposals regarding transparency of fund fees and charges; one idea is to standardise cost and fee disclosure, and whilst not considering any rule changes for the time being, the regulator is weighing whether further action on performance fees is appropriate.

However, despite recent efforts to increase transparency, many investors are still struggling to work out whether fund management fees represent value for money.

This is particularly pertinent to those trying to compare the all in costs of actively managed investment funds with the fierce competition presented by cheap passive funds, which can be bought for next to nothing.

In order to look attractive some active funds are offering new fee structures that promise reduced rates at times when the fund fails to deliver, whilst charging a higher rate if the fund outperforms its benchmark.

‘nearly all performance fees are there to line the pockets of the fund manager’

By example, Allianz Global Investors has just introduced a new low-rate fixed fee structure for a number of its equity funds; this means that if the fund does not hit its targets, fees could be close to those normally charged for a passive tracker.

However, when the fund does perform beyond its benchmark, 20% of its outperformance is applied as an additional fee; outperformance is calculated and accrued on a daily basis, and charged at the end of the year.

Whilst allowing active fund managers to promote seemingly attractive fees that appear competitive with the passives, experts have urged retail investors to err on the side of caution, saying that performance fee models can be confusing and rarely offer a genuine opportunity to cut costs.

Industry grandee Mark Dampier of Hargreaves Lansdown recently told the Telegraph:

‘Nearly all performance fees are there to line the pockets of the fund manager; they don’t align with the interest of the investor at all,’

‘Fund managers are trying to work out a system where they’re getting paid money but it doesn’t look like they’re getting paid as much… They’re trying to have their cake and eat it.’

LionTrust multi-asset fund manager John Husselbee added that performance fees have had a bad name since the early Noughties, when the high cost of hedge funds left a sour taste in the mouths of many retail investors.

He believes DIY investors will find it very difficult to get their heads around performance fee structures: ‘I don’t think you can work out whether it’s value for money until you’ve seen it in process, until you’ve seen it in action,’ he said.

 Remaining Active

Actively managed funds have not always attracted headlines for the right reasons; a perception that certain costs were being hidden in the small print was not helpful and the FCA’s initiative should help in that regard.

Coupled with that is the fact that the bull run has provided the ideal conditions for passives to strut their stuff; surfing on seemingly inexorably rising markets whilst taking fees that can be as low as single figure basis points.

However, unless it really is different this time, most would agree that what goes up, must come down and that is when good active management comes into its own – particularly now that fees have generally been coming down – and there are calls from certain industry commentators for investors to reconsider active funds.

‘those considering actively managed funds need to take a long-term view’

If, as predicted, markets are more volatile this year, active managers will be able to take advantage of opportunities to buy or sell as and when they arise, rather than hitting the peaks and the troughs with the trackers.

The DIY investor will not be unfamiliar with the old adage that ‘time in the market’ is more important than ‘timing the market’ but that is what the pros are for, and it is now cheaper than ever for you to benefit from their expertise.

According to Mr Husselbee, those considering actively managed funds need to take a long-term view and be prepared for periods of negative returns, investing ideally for a minimum of five-to-ten years.

‘When it comes to active management, if you want outsized returns, you have to be patient and you have to wait for them… Over a ten-year period, managers outperform six times out of ten,’ he told the Telegraph.

In typically forthright fashion, Mr Dampier added: ‘The idea that there are no good active fund managers is kind of a nonsense.’