Guides and Articles
Understanding Performance Fees
The Section 12J Investment Process
Section 12J Tax Overview
Important considerations before investing
For investors who find themselves having to quickly identify a Section 12J investment/s, make sure you request the latest fund fact sheet or statement from the Section 12J fund manager and be sure to consider the following key factors:
Performance fees are by far the most overlooked aspect of investing in Section 12J funds and if not understood correctly, investors and advisors may soon realise that their investment is excessively fee rich. Section 12J fund managers are largely incentivised through a performance fee which is paid out at the end of the investment term. Investors should pay particular attention to whether the performance fee is calculated on the growth of the investment only or above "the capital at risk" amount:
Gross capital performance fee:This is where a performance fee is earned on any amount above the original investment amount. In other words, if R100 is invested and after 5 years the investment is worth R120, a performance fee would only be charged on the R20 growth;
Risk capital performance fee:This is where a performance fee is earned on any amount above the "risk capital" amount (with or without a hurdle). For example, if an investor invests R100, the investor is assumed to have received a tax benefit of R45 and the investor would be charged a performance fee above his/her "risk capital" amount of R55 (R100 less R45). Therefore, if after 5 years the investment is worth R120, a performance fee would be charged on any amount above R55, which is R65 in this example;
If one ran a simple calculation in a scenario where an investor in the highest tax bracket invests R100 and the investment grows to R120 over 5 years, the gross capital performance fee would be R4 which is 20% of the investor’s profits as opposed to R13 which is 65% of the investor’s profits under a risk capital performance fee. In order to avoid confusion, ask the fund manager to provide a performance fee calculation using the above scenario.
Risk capital vs Gross capital performance fee
||Gross capital PF
||Risk capital PF
||Risk capital PF +h
|Value post 5 years
||R13 000 (65 000 x 20%)
||R8 600* (43 000 x 20%)
|Performance fee as
a % of profits
*Assuming a hurdle of 7% pa
SARS recently advised that of the R8.3 billion invested in Section 12J funds, only R3.6 billion has been re-invested. The impact of non-deployment has and will have an enormous negative impact on investors’ returns as funds sitting in cash will result in a cash drag, which will likely lead to a negative net asset value or lower than expected returns.
To ensure that investors’ capital is given an opportunity to grow, investors would be well informed to understand what percentage of capital has been invested into qualifying investments. Even more concerning is that investors in Section 12J funds which have not invested 100% of their capital, will likely be required to hold their investments for longer than expected, due to the investment taking longer to generate the returns anticipated.
Given the private equity nature of Section 12J investments, investors should know upfront that exiting these investments will take time as generally, the underlying investments would need to be disposed of. Investors should, therefore, look to invest in Section 12J funds which have a clear and realistic exit strategy and that provide the investor with comfort that investment will be exited in the timeframes expected.