UCITS: when a fund's outperformance gives rise to a significant increase in fees

Facts

Mr W told me that he had invested in a UCITS in 2011, and that when he looked at his annual statements of fees, he was surprised to see that in 2020, the cost associated with this investment was more than three times higher than what it was in 2019, rising from a total of 606.95 to 1,942.11 euros.

In order to obtain details and a justification of this amount, Mr W approached his bank on several occasions, but was unable to obtain a satisfactory response.

As a result, Mr W transferred his account to a new account keeper to protect himself against a further increase in fees.

It was against this backdrop that Mr W contacted me with a view to obtaining reimbursement of the amount invoiced for 2020 or, failing that, to obtain clear answers justifying the fees.

Investigation

I questioned Mr W's former account keeper, who told me that the ‘indirect’ fees for the UCITS to which Mr W had subscribed had indeed risen between 2019 and 2020.

More specifically, the account keeper informed me that the investment management company had invoiced for an outperformance fee in respect of 2020, which explained the increase in the ‘indirect costs and fees relating to financial instruments’ line appearing on the annual statement of fees sent to the client (in accordance with Article 325-14 of the AMF General Regulation).

The bank pointed out that this commission had been applied in accordance with the fund's key information document (KID) and prospectus, and fell within the scope of Article 321-118 of the AMF General Regulation.

Recommendation

After an in-depth analysis of the applicable regulations, I reminded Mr W that the term ‘indirect costs and fees relating to financial instruments’ includes the ‘outperformance fee’, which is a results-based commission levied if the performance objective set, as specified in the KID, is exceeded.

With regard to the UCITS in which Mr W had invested, it saw that the fund outperformed its benchmark by 28% in 2020 (whereas this outperformance was only 6% in 2019) and underperformed in all subsequent years.

In 2020, as the fund had outperformed its benchmark index, a 20% outperformance commission was charged by the fund investment management company, explaining the increase in the fees.

I have noted that this commission was indeed mentioned in the KID and prospectus for the UCITS, although it was not precisely quantified in these documents, since it is likely to vary each year and can therefore only be estimated. It is important to note that ex ante information, i.e. that provided upstream to the client, can but estimate the costs. On the other hand, periodic statements, sent once the operations have been executed (known as ‘ex post’ information), must be based on the actual costs.

In addition, in this case, I noted that the institution had duly complied with its 'ex post' information obligations, since annual statements of fees were indeed sent to the client each year to inform him of the costs and fees actually incurred over the past year.

Lastly, I drew Mr W's attention to the fact that the outperformance commission is deducted directly by the investment management company from the net asset value, and not by the account keeper itself. As a result, while the outperformance fee has a direct influence on the return on the investment, it remains no less independent of the bank, which does not determine its amount itself. Therefore, if the outperformance condition is met again in the future, the outperformance fee will apply to Mr W's new account keeper for as long as he holds his units.

Lesson to be learned

In accordance with the requirements of the MiFID II directive and, where applicable, the PRIIPs (Packaged Retail Investment and Insurance-based Products) Regulation, account keepers must regularly provide their potential or existing clients with detailed information about the costs and fees that they are being or will be charged. This information is crucial if clients are to make informed decisions. However, the difficulty lies in making the fees mentioned when subscribing to financial instruments clear and understandable, since how the fees are classified varies between the different market participants.

This dossier is a reminder of the need for investors to fully understand the fees associated with UCITS prior to committing to such investments. To do this, it is essential to pay particular attention to the terms of the UCITS’ Key Information Document (KID) and prospectus in order to understand the various components of the fees, including any variable outperformance fees.  The existence of an outperformance commission can cause the amount of fees incurred to vary significantly from one year to the next, depending on the fund's performance, which can have a considerable impact on the total cost borne by the investor.

In addition, it is important to underline that certain so-called indirect fees, such as outperformance commissions, are deducted directly by the investment management company and are independent of the account keeper.

More generally, the AMF has adopted the ESMA guidelines in a new position DOC-2021-01. The aim of these guidelines is to promote greater convergence and standardisation in the area of outperformance commissions and to encourage convergent supervision by the competent authorities.

More specifically, if a UCITS underperforms its benchmark index in a given year, a mechanism now exists whereby the investment management company may only deduct an outperformance fee for the following five years after first compensating for this underperformance.