Graham Bentley: No time for a performance fee comeback


Platforms are forcing down fund managers’ margins. Academic evidence strongly suggests that the majority of investment returns are simply market returns (beta); this explains the extraordinary rise in the use of cheap trackers and ETFs.

So what does the economically rational fund management group do – compete on price? A fund manager cheapens the value of alpha delivery by matching the market price.

Now far be it from me to suggest that a Bentley is special, but bear with me – if a Bentley Continental cost the same as a Ford Focus, Bentleys couldn’t be seriously considered “special” because they would be commonplace.

So how do you make yourself appear special? First, suggest your manager is a maverick rocket scientist who lives with his mum and does not see daylight. Be “reassuringly expensive”. Imply that previously this magician has only advised people with yachts big enough to house two submarines and anti-aircraft batteries.

Now, however, you want to share those arcane secrets with a “limited number” of discerning advisers – which means all of them. The price? 75 basis points (none of this preferential share class nonsense) – plus a performance fee.

If I charge a performance fee, I imply I am used to receiving it – QED you get performance. It also implies others will not. I will of course promise to beat a hurdle rate, or benchmark return first to make your 0.75 per cent worth something rather more than the price of admission.

However, the hurdles are generally rather less challenging than speed bumps. It really is consummate marketing to persuade an adviser that an investor should part with 75 basis points for the manager turning up, then a performance fee equivalent to 10 per cent of everything over a hurdle that a dead snail could gambol across.

I would be rather irritated if my physician charged me a flat fee for slipping on his scrubs and digging in to my duodenum, followed by a further tranche of fees payable as long as my large intestine didn’t fall out over lunch.

The majority of performance fees are gathered via annual “crystallisation” – how much performance can I get for you in a year – not least, because most regulatory regimes around the world have made it clear they take a dim view of shorter periods.

An Investment Management Association paper on performance fees once opined, “an annual crystallisation, together with a daily calculation and accrual based on the average number of units in issue during the performance fee period would remove the problem of short-term trading.”

Short-term crystallisation periods incentivise the manager to make short-term and therefore risk-laden bets by definition. I was once asked by a number of advisers to add a fund to my former employer’s platform, that had a current hurdle rate of 1.08 per cent per annum, and a crystallisation period of 10 days.

Using the prevailing FTSE 100 level at the time of 5100 as a proxy, this fund charged 1.5 per cent AMC, then claimed 10 per cent of all performance over an index level of 5102 (i.e. 2 points being 10 days’ worth of 1.08 per cent per annum) every 80 business hours, or 26 times a year.

This was not disclosed in the fact sheet, no examples were given in the KFD, and the mechanics were buried in the prospectus – completely non-compliant but then again in the mighty jungle, the FSA sleeps tonight.

There is a whiff in the air that performance fees might return, as equity markets give performance a fair wind. Here is my plea to fund managers. If you’re tempted, do not. Build smart solutions that match customers’ very simple needs, and believe me they will pay a premium for them.

Graham Bentley is managing director of Graham Bentley Investment Intelligence