Additional annual fee revenue from performance fees totals US$3.6 billion, according to new research released this week. Nearly 1,500 funds from around the globe were surveyed. One of the main conclusions from Fitzrovia International, the London-based fund research company's new report analysing performance fees for open-ended funds - the vast majority of which are open to retail investors - is that there are benefits. The report took more than two years to complete and is a unique study of its kind. 'The basic concept of investors paying more for truly superior investment management can be described unequivocally as a fair one, provided the incentive fee is properly constructed and reflects 'real' index beating performance,' said Paul Moulton, chief executive of Fitzrovia. 'The vast majority of managers of funds with performance fees have a potentially substantial upside if they perform well, but do not suffer an equivalent downside for under-performance. This is a 'heads I win, tails you lose' situation.' He said that looking forward, it may be fairer to compensate investors by way of a reduced annual management charge when introducing the performance fee structure. While 57 per cent of the funds surveyed actually earned a performance fee, they enjoyed a 180 per cent increase in fee revenues, in addition to their management charges. In the survey, Fitzrovia details a number of key factors fund managers should address for a performance fee to be fair to investors while providing sufficient incentive to fund managers. Benchmarks: Appropriate investment sector benchmarks against which fund performance can be measured. Volatility: Reducing the risk of volatile fund performance with what are termed 'high water marks' to ensure that investors do not pay twice for the same performance with a recovery to a previous high. Fee caps: A limit to the total annual charges resulting from superior performance of a fund. Administration: Importance of creating a performance-fee structure which is not so complicated that it significantly increases administration costs, which in turn have an impact on overall fund costs. Compensation: A reduced annual management charge when the performance-fee structure is introduced and/or when the fund under-performs. At the present time British-based unit trusts are prohibited from charging performance fees. But, in its survey, Fitzrovia pointed out that a fund management company could easily base a fund with a performance fee structure in Dublin or Luxemburg. It could attain an Undertakings for Collective Investments in Transferable Securities 'passport' and market the fund to retail investors in Britain. 'While there may have been a reason for restrictions on exposure to performance fees in the past, these situations show that the regulators' position no longer achieves its original goal,' Mr Moulton said.
