Fitzrovia Publishes Fund Performance Fees Study

by Phillip Morton, Investors Offshore.com

25 March 2003

Fund research firm Fitzrovia International has published the findings of a recent study on the performance fee structure of over 2,000 globally based funds.

Commenting on the study, Paul Moulton, Chief Executive of Fitzrovia observed that whilst a performance fee structure is designed to give the fund manger maximum incentive to produce a "superior return", this should not be achieved to the detriment of the investor.

The study's findings show that 40% of the funds actually attained a performance incentive-based fee system, and as a consequence their revenue climbed by 57% after management fees.

According to Moulton, whilst the current weak state of equity markets may cause funds to question their fee structure, now is the time when performance fees are most justified.

In order to compare fee structures between competing funds more effectively, as well as making them easier to comprehend for the investor, Fitzrovia set out an eight point checklist for performance fees:

1. How is the performance fee calculated? For example, the percentage of net gains or percentage of net assets that would be charged.

2. Is there a hurdle rate? If so, what is the fixed level or variable rate? This means that a performance fee will only be achieved once the manager has exceeded a risk-free rate ('hurdle') of return.

3. Is there a benchmark performance index? If so, what is it? This means that a performance fee will not be earned until a return exceeding market movements, represented by an appropriate index, can be shown.

4. Is there a High Water Mark? If so, what is its duration? Also referred to as the "Previous High". To avoid volatility being unfairly rewarded, this mechanism aims to ensure that shareholders pay performance fees only on new net gains, i.e. that they cannot pay for the same absolute increase if the net asset value per share rises, falls and then recovers.

5. Is there an equalisation system in place? Equalisation is a broad term used for calculating performance fees more fairly for existing investors, by doing so at individual shareholder level.

6. Is there a fee cap? If so, what is it? A fee cap is the limiting the percentage of a fund's net assets - not just of the net gains - which the performance fee can attain.

7. Is there a penalty for under-performance? For example, the potential to reduce the management fee.

8. What would be the impact of the performance fee in several hypothetical scenarios? For example: a) 10% fund performance, 7% index/market performance. b) 25% fund performance, 30% index/market performance. A performance fee structure that rewarded the second achievement proportionately more than the first would be of questionable integrity.

The results of the study were as follows:

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