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Performance Fee – How Funds Cup Their Investors

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Equity funds that require a performance fee, achieve lower returns than funds that do not. The main reason for this is questionable billing models, which enable funds to collect high payments despite moderate performance. More and more actively managed funds require a performance-based fee, the rating agency Morningstar has observed for several years. The so-called performance fee is due on the return that is above an agreed benchmark. The fund companies praise performance fees as an instrument that brings the interests of investors and those of fund management down to a common denominator. As a fair incentive system designed to encourage managers to perform at their best.

How funds trick when calculating the performance fee

The unabashed bag tailoring of the fund companies goes much further. When calculating the performance fee, the industry tricks where it can. For example, choosing a benchmark that is easy to beat is widespread. Flawless equity funds compare, for example, with composite benchmarks that only consist of 90 percent shares and 10 percent money market investments that hardly generate any income.  That is why equity funds will always outperform their benchmarks in good years, if only because of their higher equity allocation. The fund company then holds out its hand and collects a performance fee without having to provide an above-average performance. The performance fee is usually between 10 to 25 percent of the return above the benchmark index. In the past, the bottom line was that in extreme cases it led to total annual costs of up to 9 percent.

Duel between fund and index with a predictable outcome

Another ploy some fund companies use to rip off their investors is to simply sweep dividend payments under the rug. While the equity fund collects profit distributions, the fund company chooses a price index as a benchmark that does not take dividend payments into account. Since dividends make up a large part of the return on equities in the long term, an actively managed equity fund can hardly lose against a price index. Such questionable models have nothing to do with fair performance measurement, on the basis of which the performance fee is calculated. They only serve the purpose of regularly cupping the investors in addition. The fund industry is also pursuing this goal with a different accounting model: some funds dispense with a benchmark index and instead set a return mark at their own discretion that the fund must exceed. This brand is called the hurdle rate in technical jargon. For some funds it is zero. In these cases, the fund providers already consider a positive return to be a special service for which investors have to pay an additional performance fee.

Moreover on the fund side; the fund can only collect a performance fee again after the deficit has been made up. The providers must take into account the presentations of the past five years prior to the current accounting period. In other words: poor performance by fund management is statute-barred after five years.Positive performance: Funds that do not want to be measured against a benchmark can alternatively use positive performance as a measure of performance. A clause stating that the return must exceed a certain mark (hurdle rate) is voluntary. Funds are allowed to collect a performance fee as soon as their return is positive and the value of the fund units is above the all-time high of the previous five accounting periods. The financial industry calls the latter condition the high water mark. If the fund falls below a high, it must first make up for the losses before a performance fee can be calculated. This prevents investors from having to pay a performance fee multiple times for the same increase in value.

Hello, I have been working as an investment consultant and author for more than 20 years. I love what I do and I have enriched everyone around me. A lot of money is not important, the main thing is how you use the money.

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