Other Candid sites

Candid Financial Advice
Financial advice for a fraction of the usual cost.

Compare Fund Platforms
The UK's only fund platform comparison site for private investors.

Calculator over 80 Calculators!

Covering almost all your money needs - use them.

Protected Investment vs Tracker Funds

Calculator Protected investment plans can shield you from stockmarket falls, but usually at the expense of dividends. Use this calculator to see how these plans might fare against a tracker fund.

Random Jargon

Asset Allocation

The spread of investments across a range of investment types/assets. Can help reduce risk and improve investment return prospects.

Ask Justin

Ask Justin

| Printable version | A A A |

Should I worry about tracker fund performance fees?

Investment | Trackers Helpful? 11

Asked by hdeakin299, submitted 14 February 2011.

Open Quote This is a question about performance fees and trackers. Should I embrace this new charge or treat these fund providers as pariahs to be avoided whenever possible. Do these, initially low fees represent a bargain compared to actively managed funds or are these initial charges just "the thin end of the wedge" which will get much worse over time? I suppose this sort of question needs a "crystal" ball but I think it is worth asking as could these fees potentially end up over time being much worse than actively managed funds?

I first came across this problem a few months ago when I hurriedly did some switches and one of these was into an HSBC American Index tracker. I did not even bother to check the detail as I assumed there were no fees with trackers. But, I later found from the general information provided by the supermarket that I had got caught out by these new fees. But I did not pursue it further at that time ,but merely noted that it would be a suitable candidate for switching later on. In this week's Sunday paper I noticed these performance fees for trackers were discussed: they were not ruled by the journalist out as it seems their charges are currently lower than most active funds. So I now have a dilemma as to what to do (come April).
End Quote

Answered by Justin on 15 February 2011

I think your question refers in part to the recent launch by JP Morgan Asset Management of 'active' tracker funds with performance fees.

I'll cover that in a moment, but first a quick overview of annual fund fees. All funds, even trackers, charge an annual management fee, which is deducted by the fund manager on a daily basis from your investment. Tracker funds usually charge 0.5% or less a year while actively managed funds tend to charge around 1.5%. This fee represents revenue to the fund manager, but they may pay sales commissions (c0.5%, less or zero on trackers) and fund supermarket charges (c0.25%) from this depending on how the fund is sold.

On top of this annual management fee there will be other charges paid directly from the fund, such as trustee, auditor and registrar fees, which typically add a further 0.1% - 0.2% to total annual charges. The impact of these fees combined with the annual management charge is reflected by a total expense ratio (TER) figure - which you should see quoted on fund factsheets/literature etc.

The fund will also pay dealing charges when buying and selling shares. These are seldom explicitly listed and simply reflected in actual fund returns. Some estimates suggest they could add several percent to overall costs on funds that trade particularly frequently, but the bottom line is whether a manager can beat a comparable index after all costs.

Performance fees are normally on top of these annual charges and typically charged at a percentage of overall returns or returns in excess of a pre-agreed amount (called a 'hurdle' rate). They can be a good thing provided the fund manager reduces their usual annual management charge, as it gives the manager a greater financial incentive to perform and leaves them worse (than usual) if they don't. However, most performance fees to date have been very greedy, with managers simply sticking them on top of their usual fees - a win-win for them but far less appealing for you. It's also important to check whether a performance fee has a 'high watermark', meaning the fee can't be charged on performance that doesn't exceed the fund's previous highest value. Otherwise the manager could, for example, return 20% and pocket a performance fee, lose 25% then recover 10% and charge another performance fee, even though you've lost money overall.

The JPM UK Active Index Plus fund is essentially a FTSE All Share Index tracker fund that allows the manager to actively tweak holdings a small amount versus the index, with a view to beating it.

The annual management charge is 0.25% with other costs of 0.15% to give a TER of 0.4%. The performance fee is charged at 10% of returns above the FTSE All Share Index (without a high watermark), but is capped to ensure the TER does not exceed 0.55%. I'll try and review the fund in more depth soon, but on the surface this seems a reasonable deal. However, the annual charge doesn't include any sales commission, so don't expect financial advisers to be overly enthusiastic about the fund.

The HSBC American Index fund charges 0.25% a year with 0.03% of extra costs giving a TER of 0.28% - a pretty competitive deal for a US tracker fund. There is no performance fee despite Fidelity FundsNetwork's website suggesting otherwise (I assume this is an error).

I agree that fund charges are a big issue. Far too many active fund managers charge far too much and fail to deliver. Some tracker funds also charge excessive amounts (e.g. the Virgin Index Tracker at 1% a year). But there are also many, good, low cost tracker funds that can be worthwhile.

I would be concerned if tracker funds start to levy performance fees, but this is very unlikely given they mostly, by definition, underperform the index a little due to annual management charges (assuming they track the index 100% accurately).

Please note this answer does not constitute a recommendation or financial advice and should not be relied upon when making specific investment or other financial decisions. You should always undertake your own research into whether a product or service is appropriate for your needs and, if necessary, use a qualified professional adviser.

If you found this answer helpful, please add your vote by clicking here.

Readers' Comments (0) - To post a comment please register or login .