Reviewing investment company performance fees

Those who seek to hold businesses and their managers to account often talk about the need to align the interests of executives and shareholders – in other words to pay the directors more when the company’s performance is good and less when it disappoints. That feels intuitively right – for one thing, it obeys the principles of natural justice; for another it gives the managers of the companies in which you’ve invested an incentive to do better for you.

In the investment companies sector, however, performance-related fees are becoming less common, with a string of funds moving away from such charges over the past couple of years, or at least reining back on their generosity.

The latest to do so are Nick Train and Michael Lindsell, the managers of the Lindsell Train investment trust. They previously charged a performance fee linked to the market capitalisation of the fund; henceforth the fee will be linked to the value of its assets, which is likely to mean a smaller pay-out because the fund’s shares typically trade at a premium to the value of the underlying portfolio.

In making these changes, Lindsell Train is following a long line of investment companies doing something similar. Last month, for example, the Baring Emerging Europe Trust scrapped its performance fee altogether, while JPMorgan Emerging Markets has recently done the same thing.

In part, this reflects a wider trend towards lower charges – the AIC reckons 10 per cent of the industry improved its fees last year. That was a response to competition from the open-ended fund sector, where the outlawing of commission under the retail distribution review reforms of three years ago has seen the price of open-ended funds fall.

This price competition is good news for the end investor, of course. But some investors – and their advisers – may be disappointed to see investment companies moving away from performance fees; instead these funds are moving to a model where they make the same flat-rate charge irrespective of the quality of the manager’s track record.

It’s worth making a couple of points here. First, all investment company charges are, in reality, a performance fee. Even plain vanilla annual fees are typically levied as a percentage of funds under management or of market consolidation – both rise and fall, in good part, according to how well the manager performs.

Also, there are a number of funds that are reforming their performance fees rather than getting rid of them altogether. That includes Lindsell Train, which rather than scrapping the levy it charges has chosen to link it to net asset value rather than share price. That seems like a more relevant yardstick on which to decide how to pay the managers.

Nevertheless, there does seem to be something of a backlash against performance fees in the investment company sector – this may even be linked to anger about excess pay awards to managers in the broader economy.

It’s important not to throw the baby out with the bathwater on this issue. Investment company boards should be reviewing their charges regularly - and getting rid of uncompetitive or outdated fees – but there is something to be said for a fee that holds the manager to account. And where the yardsticks are sufficiently rigorous and challenging, why not incentivise the executive teams charged with delivering strong performance?