Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Why many investment trusts are abolishing performance fees
Management and performance fees may not be the most important consideration when weighing up the merits of particular investment trust, but they are certainly key. The greater the costs of a fund, the harder your investments have to work to generate a positive return.
Investment companies pay a fee to fund managers for managing the portfolio. They may also pay a performance fee, if the manager outperforms certain targets. This can also serve to constrain investors’ returns.
Active funds’ fees are frequently under the microscope, as some funds are accused of overcharging investors despite delivering poor returns; in part, this explains the popularity of passive funds where many products have significantly lower fees.
RINGING-IN THE CHANGES
Investment trusts have long enjoyed a fee advantage over unit trusts, usually being cheaper investments, although this has narrowed since 2013 when regulation compelled unit trusts to issue cheaper ‘clean’ share classes.
Numerous trusts are now abolishing performance fees – recent examples include Premier Global Infrastructure (PGIT), Henderson Diversified Income (HDIV), Aberdeen Frontier Markets (AFMC), Perpetual Income & Growth (PLI) and F&C Commercial Property (FCPT).
Scrapping performance fees plays a part in a trust becoming more competitive and transparent on costs amid tough competition from the open-ended funds sector, although cynics could argue many have struggled to outperform benchmarks and trigger performance fee payments in any event.
The communications director of industry body the AIC, Annabel Brodie-Smith, tells Shares the move away from performance fees demonstrates the value of investment companies’ independent board of directors who represent shareholders’ interests.
‘The AIC view is that performance fees can align the managers’ interests with shareholders but they need to be carefully structured by boards to ensure they meet their purpose effectively.’
PERFORMANCE FEE ABOLITION
BlackRock Smaller Companies Trust (BRSC), currently trading on a 10.2% discount, has announced (17 Apr) new fee arrangements with manager BlackRock, effective from 1 March 2018. Mike Prentis-steered, the trust will now have an investment management fee of 0.6% on the first £750m of total assets (less current liabilities), reducing to 0.5% thereafter, and has also shelved the performance fee.
Prior to these important changes, the trust paid a 0.65% management fee on the first £150m of assets, dropping to 0.5% thereafter, while the performance fee was based on 10% of the yearly outperformance of the benchmark in the two previous financial years, applied to the average of the total assets.
In fact, this performance fee had been capped each year (at 0.25%) due to the company’s strong performance. As at 31 March 2018, BlackRock Smaller Companies had delivered one, three and five year NAV growth (without income reinvested) of 16.1%, 57% and 102.1% respectively.
This compared favourably to the 4.4%, 24.2% and 38.7% generated by the Numis ex Inv Companies + AIM index. Recent strong portfolio performers for the trust include Avon Rubber (AVON), materials tech firm Zotefoams (ZTF) and Dechra Pharmaceuticals (DPH).
BlackRock Smaller Companies’ board even quantifies the saving. Had the new fee arrangements been applied for the year ended 28 February 2018, total fees payable to BlackRock would have been ‘approximately 20% (£1.1m) lower; and the total operating charges ratio (inclusive of performance fees) would have been reduced from 0.93% to 0.77%’.
Languishing on an 11.5% discount, another fund that has materially reduced running costs is Jupiter US Smaller Companies (JUS). The company has acted to ensure its charges are competitive versus sector peers and the institutional unit class of the Jupiter US Small & Mid Cap Fund, with which it shares a manager in Robert Siddles.
Jupiter US Smaller Companies has not only abolished the performance fee, but also with effect from 1 October, its management fee has reduced from 0.8% of total assets to a tiered fee amounting to 0.75% of adjusted net assets up to £150m, reducing to 0.65% for net assets over £150m and up to £250m, and reducing further to 0.55% if net assets top £250m.
Performance over the past few years has disappointed with successful stocks sold too soon, poorly performing ones held too long and the portfolio traded too quickly. Yet Siddles now intends to sell poor performing stocks promptly, and run his winners for longer, from a more concentrated portfolio.
Jupiter US Smaller Companies offers exposure to an interesting, under-researched sector with pockets of undiscovered value. Its eclectic batch of names spans speciality food distributor Chefs’ Warehouse, insurance underwriter Alleghany, agrichemicals producer American Vanguard and regional bank Pacific Premier Bancorp.
Shares intends to explore the underlying portfolio and inspect the performance in detail in a future article.
In November, fund-of-funds Aberdeen Emerging Markets (AEMC) pared its annual management fee from 1% to 0.8% of net assets and has also discarded the performance fee.
Allied to the recently introduced dividend, these changes should enhance the fund’s attractiveness to existing and potential investors. However, no performance fee has been paid since the £2.48m fee paid back in 2010, according to the AIC.
Aberdeen Emerging Markets claims to offer investors exposure to ‘some of the best investment talent within the global emerging markets of Asia, Eastern Europe, Africa and Latin America’.
However, its NAV total return of 14.9% for the year to 31 October 2017 lagged the 16.6% total return of the benchmark MSCI Emerging Markets Net Total Return Index. An underweight exposure to China and the technology sector proved to be a drag on performance. (JC)
THE EXPERTS’ VIEW:
‘The decision of the BlackRock Smaller Companies’ board to remove the performance fee reflects the trend that has seen over 45 investment companies removing performance incentives since 2012.
‘Performance fees have fallen out of favour with retail/private wealth investors in recent years, partly because they make fee comparisons more difficult.
‘We would argue that a low base fee combined with a well-structured performance fee rewards a manager for delivering outperformance rather than growing assets, which should align their interests with shareholders.
‘The key is that a performance fee is not excessively generous and does not simply reward higher risk. In our view, there are also merits in a performance fee that is simple and easy for
investors to understand.
‘Our key criticism of the performance fee for BlackRock Smaller Companies was that it was charged based on gross assets, even though it is calculated on net assets. Similarly, we believe that base fees should be charged on net assets rather than gross assets.’
THE INVESTMENT TRUST TEAM AT NUMIS