Some managers structure their ongoing fees to be based on the performance of the funds. These performance fees therefore vary depending on how well your fund manager managed your fund and the returns you earn.
They are only used by some fund managers and only on certain funds, particularly those with equity exposure.
The Association of Savings and Investments South Africa (ASISA), to which most South African unit trust companies and asset managers belong, has drawn up a performance fee standard that standardises the terms used to disclose performance fees and sets guidelines on how to set fair fees.
The standard sets out the terms managers should use when explaining their performance-based fees:
The base fee and the minimum fee
The base fee is the fixed part of the annual management fee that the manager will charge before any performance is taken into account.
A few set the base fee at 0% – that is they have no minimum fee - and all their charges depend on performance.
ASISA’s performance fee standard says generally the base fee of a fund with a performance fee should be lower than the flat fee charged on a similar fund. However, it acknowledges that the base fee should not be considered in isolation, but rather as a component of the total fee.
Funds may also set a minimum fee that they can charge to cover ongoing costs the fund incurs and a fee for when the fund performs in line with its benchmark. These fees may or may not be the same as the base fee.
The performance fee benchmark
This is the yardstick against which the performance of the fund is measured in order for the manager to determine if a performance fee applies.
Typically the performance fee benchmark is the fund’s regular benchmark, such as the FTSE/JSE All Share in case of an equity fund, or the All Bond index in the case of a bond fund, or a composite of a few indices in the case of a multi-asset fund.
ASISA’s performance fee standard says funds should only have one performance fee benchmark.
It also says the managers should not change the performance fee benchmark or components of the performance fee structure without giving due notice to investors.
The fee hurdle
This is the level of performance the fund must achieve before the manager can charge a performance fee.
The fee hurdle should be linked to the performance fee benchmark. For example, if the fee benchmark is the FTSE JSE All Share Index (AlSI), the fee hurdle could be the index plus two percentage points (AlSI + 2%).
The performance fee measurement period
This is the period over which the fund’s performance will be compared to the fee hurdle over the same period for the purposes of working out the performance fee.
Many funds use rolling returns – that is returns measured over a period that moves on each day. Performance over a rolling one-year period to yesterday, for example, considers performance for exactly a year to yesterday. Today, the one year-period will measure performance over a one-year period that starts from a day later.
The sharing ratio
Performance fees are typically expressed as a percentage of the return that exceeds the fee hurdle when returns are measured over the relevant period.
For example, the performance fee may be expressed as 20% of the return above the JSE All Share Index (ALSI) + 2% over one year.
The percentage of the returns above the fee hurdle that the manager is entitled to take as a fee is known as the sharing ratio – it is the portion of the performance the manager shares with you, the investor.
ASISA members are of the view that a sharing ratio above 25% could be considered, but say the way in which this ratio is applied within the whole performance fee structure, should be taken into account.
The high watermark
Performance fees may include a high watermark that records the highest level of performance above the hurdle that the fund reached.
When a fund with a high watermark earns negative returns, the performance fees should be suspended until the fund regains what it lost and exceeds its high watermark.
ASISA’s standard says the high watermark should only reset when the losses are made up and the performance fees start applying again.
The performance fee accrual frequency and payment frequency
The performance fee accrual frequency refers to how often the performance fees above the minimum are calculated and provided for in the fund.
The payment frequency refers to how often these fees are actually transferred from the fund to the manager.
These periods may not necessarily be the same and may not necessarily be the same as the performance fee measurement period.
The maximum fee
Some managers set a limit on how high the total (base and performance) fee can be – they set a maximum fee. Others leave their total fees uncapped.
ASISA’s performance fee standard says this maximum fee should include the base fee and the performance fee.
It also says that if there is no maximum fee, the fund should have a high watermark of the performance above the hurdle since the fund launched (since inception).
Designing fair fees
ASISA’s performance fee standard says there are many ways managers can calculate performance fees and there are none that will always be better than others.
Managers need to select and design fees most appropriate for their circumstances and the mandate of the fund.
However in doing so, the standard urges managers to use appropriate benchmarks, hurdles and behaviour. It identifies the following as inappropriate:
Hurdles that do not relate to the fund’s performance benchmark. For example, an equity fund should not have an All Share Index benchmark and set its performance fee hurdle to be outperforming cash by a certain number of percentage points eg cash plus 2%.
Inflation benchmarks for equity funds.
Inflation-linked benchmarks for a multi-asset fund when this is not in line with its risk profile. For example, a fund that takes investment risk aimed at achieving inflation plus 5% should not set a performance fee hurdle of inflation plus 3%.
Any performance fee for money market funds.
Any hurdle that is lower than the performance benchmark when calculating fees for performance equal to the benchmark.
Symmetry
ASISA’s performance fee standard says performance fee should aim for symmetry over full market cycles – with individual fee levels that are appropriate.
The standard says there are various ways this symmetry can be achieved, including:
When performance is below par
Some, but not all, funds reduce their fees when performance is below the benchmark and/or returns are negative. South African funds use performance fee structures that:
