In the post-RDR debate on charges, some call for a flat rate to challenge open-ended funds. But the complexity of trust management warrants a performance fee built into the pricing
Investment trust management fees have come under scrutiny following the introduction of the RDR. The long overdue abolition of trail commissions and the welcome decision of the Financial Conduct Authority not to allow product providers to pay platform fees have led to the creation of the clean share class for open-ended retail funds.
This new clean share class enjoys a reduced management fee which for equity funds is typically 0.75 per cent. Of course, not all investors can access this new share class but many are optimistic it will be generally available in the not too distant future. Some commentators argue that investment trusts need to take this into account in determining their management fees as closed-ended funds are competing for a broadly similar investor base; and of course they are right.
But what should investment trusts do? They are, after all, very different from open-ended funds and require significantly more day-to-day management.
The reality is there is no consensus in the market about the direction of investment trust fees. Some believe investment trusts should adopt a flat base fee and no performance fee approach so they can be directly comparable to open-ended funds. Others believe investment trusts should differentiate themselves by having a lower base fee than an open-ended fund and a performance fee that might lead to higher fees than an open-ended fund if outperformance is delivered.
One thing is for certain is there will be no common industry wide approach as investment trust management fees are negotiated with an independent board rather than determined by the fund manager. In many cases this has led to existing investment trust fees being well below the 0.75 per cent level.
Indeed most independent boards go further and closely monitor their total on-going charges to ensure they remain competitive compared with their peers and open ended funds. As the below table shows, the cost benefit of investment trusts over open-ended funds has always been stark.
This cost advantage is likely to continue for the older, larger and more liquid investment trusts notwithstanding the introduction of the clean share class. However, there are many investment trusts with base fees about 0.75 per cent or higher who may well seek a reduction in management fees in order to maintain this cost advantage. This desire for a competitive edge can only be good for investors generally.
The view that investment trusts must fall into line with open-ended funds and have easily comparable flat base management fees and no performance fee looks attractive at face value. Indeed, it might be the right answer in some cases, particularly with the large, liquid and more generalist investment trusts which may be attractive to a much wider investor base than is usual for investment trusts, but certainly is not in many others.
Our clear responsibility is to set fees that are fair, clear, and not misleading and I see no reason why this cannot include performance fees if the independent board of the investment trust and the manager both believe the arrangement is in shareholders’ interests.
I believe performance fees should be a characteristic of investment trust pricing as they align the interests of the board/shareholders and the manager and they have the potential to attract and retain the best portfolio managers. Why pay a flat fee of 0.75 per cent regardless of whether the manager has outperformed or underperformed?
I believe that shareholders would, in most cases, prefer to pay a lower fee than 0.75 per cent if performance disappoints but are generally happy to share outperformance with the manager if there is a reasonable performance hurdle and total fees in any one year are capped at a reasonable level. Also high watermark protection means that any underperformance has to be made up before a performance fee can be earned in any future year.
Investment trusts are different and should revel in their distinctiveness to differentiate them from their open-ended competitors. Investment trusts, because of their listed company structure, discounts and premiums, bid/offer spread on the purchase and sale of shares and ability to gear, have always been a little more complex than open-ended funds so incorporating a performance fee arrangement that is fair, clear and not misleading should not deter investors looking for the right investment opportunity for them. For those investors who take the trouble to understand them, investment trusts have often proved to be a rewarding experience.
Fees have never been the key determinant for investors making an investment decision; that will always be the quality of the portfolio management team. Aligning the interests of that portfolio management team with your interest as an investor and shareholder seems to me to be a worthy goal and one that should not be sacrificed at the altar of homogeneity.
James de Sausmarez is director and head of Investment trusts at Henderson Global Investors.