Editor’s Letter – April 2015

Issue 103

Originally published in the issue

Quarterly performance fee calculation may seem too dull to discuss, but in years such as 2014 or 2008, paying managers quarterly as opposed to annually can make a big difference to the net returns investors receive. Both 2008 and 2014 were “years of two halves” for some managers in asset classes and strategies including oil, US high-yield bonds and merger arbitrage. Some managers and platforms getting quarterly fees locked in their first half payments, despite ending the year down, resulting in unusually wide full-year tracking error versus feeders charging annually. Some quarterly feeders have been shut down so swiftly that their performance may now need to be excavated from graveyard databases (or simply requested from some managers, including GIPS-compliant ones!). Whether investors wishing to stay invested can carry forward their personal high-water marks to other vehicles varies between managers.

Platforms that levy performance fees quarterly do not seem to aggressively advertise the fact. Sophisticated investors – who are assumed to have read the offering documents – should not be surprised. Where platforms also cater for retail investors, who may lack familiarity or experience with performance fees, should factsheets, pitch-books and KIIDs flag up an explicit warning that quarterly performance fee calculation may result in returns lower than those on feeders applying the fee annually?

The shorter the performance fee calculation period, the greater the probability that investors pay more than the headline performance fee percentage – or indeed pay a performance fee despite negative returns, and series accounting can throw up the same issues absent netting amongst series. Quarterly performance fees will also usually imply, three quarters out of four, that performance fees are struck on unaudited performance, whereas calendar year performance fees will usually be synchronised with the audit date. Whether performance, and associated fees, can be adjusted upon any audit restatement of NAV is another question that varies by manager.

When Donald Pepper of Old Mutual (whose recent interview with The Hedge Fund Journal is in this issue) first arrived in 2012 he told us how he had shifted the periodicity of performance fee payments on Old Mutual hedge funds to annual, from quarterly. Deutsche Bank’s DB Platinum platform made the same change, for most of its funds, on 1 January of this year and nearly all funds on the BAML platform charge performance fees annually.

Yet even annual performance fee payment seems a rather short period when compared with how long key staff must wait to cash in their bonuses. Lots of larger hedge fund groups – including several of those featured in this issue – began deferring bonuses over multi-year periods many years before regulators required it. Now that AIFMD and other regulations are forcing more managers to defer a greater proportion of variable compensation for certain staff, it seems more anomalous than ever for certain managers and platforms to be receiving performance fees based on quarterly performance.