HOW NOT TO INTRODUCE A PERFORMANCE FEE

By STEPHEN MARRIOTT 18/11/2005

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Bestinvest has long been urging fund groups to switch to a performance based charging structure, so it may come as something of a surprise that we are urging investors to vote AGAINST the proposals for the Merrill Lynch UK Alpha fund. One reason for having some qualms is that this fund was only launched in April, so it seems mighty soon to be asking holders to agree to a change in the basis. Apparently Merrill Lynch’s systems were not able to handle this arrangement at that time. The more important reason though is that the terms proposed represent a poor deal for unit holders. The present arrangements allow for the payment of 1.75% per annum to the manager. Under the proposals this will be replaced with a flat fee of 1% plus 20% of any positive performance. Whilst this does have the benefit of achieving a better alignment of interests between the manager and investors, it also means that the manager will be better off financially unless the fund performs very poorly. In fact there is a concern that the manager might take on more risk than is appropriate because there is a 20% participation in profits but no exposure to losses. We calculate that the break-even point (at which the new fee arrangement is identical to the existing one) would result in a net return to investors of only just over 3% per annum. We think this is far too low. Merrill Lynch would actually be significantly better off in that situation because they are reducing the trail commission payable to advisers from 0.5% to 0.25%. This fund has actually performed well since its launch and we have found it attractive for investors who are looking for an absolute return vehicle. It is most unfortunate that Merrill Lynch have not produced a more equitable proposal.

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Source: Financial Express