GLOBAL - Investors in fund-of-funds are targeting management - rather than performance fees - as they increase pressure on fund managers to lower overall fee levels, according to a new INREV report. 

The survey of 41 non-listed fund-of-funds invested primarily in Europe and Asia found significant variation in both the type and level of fees. However, management fees were broadly lower for fund-of-funds than for direct non-listed real estate funds - a consequence of less intensive asset management.

European closed-end fund-of-funds reported the highest management fees. Nearly 40% of the mostly core and value-added funds surveyed charge different management fees during and after the commitment period.

The report found that core funds were more likely to base fees on net asset value (NAV) when compared with value-added vehicles, which used both NAV and commitments to underlying funds.

The average NAV-based annual management fee was 0.37% - lower than the fees based on underlying funds, drawn commitment or invested equity. NAV-based fees were lower for fund-of-funds targeting between €500m -1bn than for those targeting equity below €500m. Those with NAV below €100m in turn carried a higher NAV-based management fee than their larger counterparts.

Performance fees levied by 63.4% of the sample varied depending on the style of the fund, with 88% of value-added and opportunistic funds charging a performance fee compared with 15% of core funds.

Despite pressure on overall fees, fund-of-fund investors were willing to accept performance fees where they reflected the investors' own interests and given an acceptable balance between management fees and performance fees. 

"The fees of funds-of-funds need to be linked to income-generation, similar to the underlying funds as well," said the report's authors, adding that a specific benchmark would ensure the fund had not generated outperformance by gearing.

In fact, the report recommended investors link hurdle rates to specific indices rather than target returns. "Currently in many cases the hurdle rates are set below the target return, while[…] these should be set above target returns to stimulate extra effort once the target return has been reached," it said.

Yet its authors also hinted that some investors lacked awareness of how performance fees were generated.  "Investors need to understand the performance fee mechanism to prevent fund managers taking higher risks to generate a higher performance fee," they concluded.