Performance Fees

purch

This is because an absolute return fund is actually a very different beast to a normal fund. Alpha (the sort of returns you hope get from these funds) is much mor expensive than Beta (which are the sort of returns that dominate most mutual fund investments).

That's what the AMC is for.

Not an argument for a Performance Fee

A fund like Absolute Alpha takes little to no market risk

Neither is that.

john_s_2

This tickled my curiosity so I've been looking at this. The China Special Situations was mentioned above so I Googled this and it says that there is a 15% performance fee if it performs over (some index or other), on top of a 1.5% management charge.

As princeofpounds said in an earlier post, this *could* be balanced out by charging a lower management charge than would have otherwise been charged.

This fund also caps the performance fee at 1.5% of the NAV. So if the max performance fee was achieved then you would pay 3% overall.

Any higher growth and this would be charged at only 1.5% again.

So presumably (and this is the rub) the fund is charging this instead of a higher management fee.

So any performance below the benchmark charges a lower fee (overall) than the fee they could have charged instead, and any performance over the cap also charges a lower fee. I guess this could deter the manager to perform better than the cap. On the flipside (from the fund company's point of view) it could perhaps incentivise him/her to concentrate on other funds that aren't performing as well as they could be. (I know Mr Bolton won't be looking after other funds but he could perhaps release staff to look after other funds.)

Just a few half-baked thoughts on my part.

fg22

The problem is performance fees don't align the manager's interests with that of the investor and instead reward them for taking more risk.

Consider for example a manager who is just short of the hurdle. He may then gamble on a particular investment in the hope of exceeding the hurdle and receiving a performance fee. However, if he fails he loses nothing.

Managers can increase their rewards by increasing the volatility of the fund while not actually increasing returns.


If fees are higher in the UK than the US, the question to be asked is why?

There may be some economy of scales over there but I suggest in part it is down to distribution channels. Here many use financial advisers who currently have no reason to discourage investments in high charging products. If the product charges more, then there is scope for more to be paid as commission. Others use supermarkets such as H-L who I doubt have any problem in promoting those with high charges so long as they get paid for doing so.

RayWolfe

john_s wrote: »

there is a 15% performance fee if it performs over (some index or other), on top of a 1.5% management charge.

As princeofpounds said in an earlier post, this *could* be balanced out by charging a lower management charge than would have otherwise been charged.

But 1.5% is pretty standard for most UTs but on the high side for a IT. Perhaps if these guys charged 0.5% annual + costs then had a performance fee, that may be more reasonable.
What I still don't understand is why it is so prevalent today, yet didn't exist yesterday. As Merrin said in her article, it makes a lot of sense in the industry, but none to the investing public.

Linton

RayWolfe wrote: »

I refuse to buy investment products with a performance fee. Am I wrong?

I believe so, unless you can demonstrate that this gives you higher returns. From my point of view I am only interested in the return to me. What anyone else gets is irrelevent. Its no different to any other goods or service - when at a restaurant do you check on the cost of ingredients and worry about the markup or do you base your judgement on your enjoyment of the meal?

Rollinghome

Linton wrote: »

I believe so, unless you can demonstrate that this gives you higher returns. From my point of view I am only interested in the return to me. What anyone else gets is irrelevent. Its no different to any other goods or service - when at a restaurant do you check on the cost of ingredients and worry about the markup or do you base your judgement on your enjoyment of the meal?

I think where your analogy falls down is that charging more for a meal doesn't make it more difficult for the chef to produce the required end product - i.e. good food.

Investment is the opposite. Charging higher fees does make it harder for the fund manager to pruduce the required end product - the best returns. All fees are a drag on returns.

Furthermore you will be able to judge instantly if your meal was good value. But it may be many years before you discover that a fund that charged you high fees was not.

Rollinghome

fg22 wrote: »

The problem is performance fees don't align the manager's interests with that of the investor and instead reward them for taking more risk.

Indeed, as was demonstrated by Nick Leeson followed by Applegarth at Northern Rock, Fred the Shred at RBS et al.

It's a high-rolling version of the old racing tipster's scam. Show your gratitude by paying him 20% of your winnings when the tipped horse wins - but he doesn't repay your stake if you lose (and gives every punter a different horse for the same race).

RayWolfe

Mmm, this double or quits is becoming rife.
Even in the boardroom; you get £2M + £2M pension pot, for doing your job; a further £10, for doing your job well. Don't do your job and you get a golden goodbye and your pension pot. Tails we lose, heads we lose big time.
I suppose, it's because they're worth it. Just like Anthony Bolton who must be worth it even though he has no experience in China and will only be running the fund for 2 years although the PF lasts forever.

Anyway, thanks everyone for your thoughts ... I'm still sticking out for not buying these offerings ... perhaps cutting off my nose to spite my face.

StevieJ

Rollinghome wrote: »

Indeed, as was demonstrated by Nick Leeson followed by Applegarth at Northern Rock, Fred the Shred at RBS et al.

It's a high-rolling version of the old racing tipster's scam. Show your gratitude by paying him 20% of your winnings when the tipped horse wins - but he doesn't repay your stake if you lose (and gives every punter a different horse for the same race).

I was impressed when I read about that one, illusion at its best :eek: the odd one will even get a 50-1 winner.

princeofpounds

You talk as if "these products" have a single identity. They don't.

Absolute return funds DO have a single strategy at core, which is to hedge out market exposure by offsetting long positions with short positions. Just because they use market instruments does not mean they bear market risk. Below is a starting point to understand this.

http://www.investopedia.com/terms/m/marketneutral.asp

http://www.investopedia.com/terms/a/absolutereturn.asp

For the investor paying a performance fee for a return below the return on cashand yet retaining considerable risk is a nonsense.

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Paying a performance fee for a return below cash is a stupid thing to do, if your only objective is a risk-free investment. However, when make a decision to stray away from the risk-free asset it is not quite so simple.

That is because it is not only absolute reward that is a valuable thing in an investment, but also the risk. In particular, risks with low co-variability to the pre-existing risks in your portfolio can give you a more efficient risk-reward profile overall even if the reward for that particular investment is not obviously attractive.

http://www.investopedia.com/articles/financial-theory/08/reduce-risk.asp
(The linked material is a bit simplistic but again will do for a start).

You do retain some risk in an absolute return strategy, although saying that it is 'considerable' is totally meaningless. Risk numbers make little sense unless they are viewed in the context of portfolio theory. for instance, two risky but uncorrelated investments can be less risky than a single less risky investments.

Another example of people being willing to pay extra for a non-correlated risk which doesn't guarantee any particularly great returns is exotic beta. Take a look at the report below, and in particular note that alpha (the type of risk an absolute return fund delivers to you) is noted as an entirely different sort of return source compared to beta (which is what the market gives you).

http://www2.goldmansachs.com/gsam/pdfs/USI/education/aa_beyond_alpha.pdf

One final word on 'considerable' risk - you can run an absolute return fund in a very risky or very unrisky way simply by scaling the bets. If the fund only returned 1% as the example you use has (and assuming that is a typical return) then that is not risky at all as the volatility of returns is very low. Just because the market went up or down over that time is totally irrelevant - if oyu want to compare a fund to the market go buy an actively managed mutual fund that will give you alpha and beta, and forget absolute return strategies.