Is “pay for performance” the future for fund fees?
Posted by Robin Powell on October 19, 2016
I don’t recommend that investors use actively managed funds, for reasons I’ve explained many times. But that doesn’t mean that I disapprove of active management in principle. Ultimately, we need active managers to help set prices and to keep markets efficient and, as Vanguard Bill McNabb told me last week, there will always be a place for low-cost active funds.
Better still than low-cost funds are no-cost funds — or at least funds that will only charge you if they outperform, and will refund any fees you pay if they underperform. One fund house whose fee structure really interests me is Orbis Access. In this interview, Dan Brocklebank, the head of the company’s UK division, explains how its fees work and how he expects more active managers to move to these sorts of fee models in the future.
Please note, this is not in any way in endorsement of Orbis Access, but I applaud its approach. Investors have made through the nose for underperformance for far too long.
Like me, you’re concerned about the lack of transparency in asset management, particularly around fees and charges. Why is that?
It’s all about enabling investors to make better decisions rather than transparency for its own sake. As you know, costs and charges add up and, due to compounding, they can have an enormous cumulative impact over the long term. So if you don’t even know how much you are paying, you are setting yourself up for a nasty surprise in the future. That’s not to say that costs are the only thing that matters. I think it’s more important to focus on value for money. But that’s nearly impossible to do without clear and complete information on the cost side of the equation.
Who exactly are Orbis and what do you do?
We are a global investment management firm founded in 1989. Our investment approach is pretty straightforward — bottom-up, value-oriented stockpicking based on fundamental analysis, contrarian thinking, and a long-term perspective. Today we look after approximately $30 billion of client capital with 40 equity analysts on the team and 11 offices globally. We are privately owned and a substantial majority of our profits flow to our founding family’s philanthropic foundation. Personally, I have been with the firm for 15 years as part of the investment team and currently serve as Head of the UK, where we have 175 people. We manage about £1.5 billion of assets for UK-based clients.
You’ve recently introduced a range of retail funds with fees based purely on performance. Explain how that works.
One of the things I’m particularly passionate about is making Orbis’ expertise accessible to everyone. Our retail platform in the UK, Orbis Access, allows individuals to invest with us starting at just £1. To be crystal clear: the person who invests £1 or £1000 with us is investing in precisely the same strategies as a £1 billion investor. And they are the same strategies that our investment team and senior management team are personally invested in — quite often with the majority of their personal wealth. Importantly, there are no special fee classes or discounts for staff. So we really are “in it together” with our clients. This is not a trivial matter for them or for us. The fee model is very simple in principle. At Orbis Access, we don’t get paid anything unless we outperform. And we also absorb many of the operational expenses that other managers typically pass along to their clients. So if you invest with Orbis Access and we deliver performance that is in line with the benchmark, you will actually pay less than you would with a tracker fund!
As you say, the danger with this fee model for you is that if you don’t outperform, you don’t get paid. You must have considerable faith in your ability to beat the market?
Obviously there are no guarantees in investing, but we have been doing this for more than 26 years and we have seen our approach work in all sorts of market environments and across different countries and regions. After taking all costs and charges into account, in sterling terms, our flagship Global Equity strategy has delivered 12.6% pa returns since 1990 vs about 7.5% pa for the benchmark FTSE World Index. That said, our fee model does indeed expose us to some very uncomfortable times. But we are accustomed to this as well, having offered some sort of performance-based fee since our firm’s inception. To be frank, we don’t think we deserve to be in business if we can’t add long-term value for clients, and we think that’s exactly the way it should be.
In what ways do you think you have an edge over other active managers?
One of the reasons we’ve been successful for our clients is that we take a long-term and often contrarian perspective. In a world that seems increasingly obsessed with short-term headlines and chasing the latest fads, we believe there will always be ample opportunities for patient investors like ourselves to exploit cycles of excessive pessimism and optimism.
Surely every manager is going to say that they can beat the market. But the data shows that only a tiny number of funds actually do so over the long term.
That’s true, but I think there is also a fair bit of misunderstanding here. There are lots of very smart people in this industry who work incredibly hard. So I don’t think one can say there’s been a lack of brainpower or effort or even a lack of skill. Instead, I think it is really a question of incentives. Think about it this way: there are really only two ways for an asset management business to grow — either deliver better performance such that the asset base grows faster than the market’s return or go out and find new clients. But outperforming by even, say, 5% per annum is exceptionally hard, whereas bringing in 5% more client assets is a pretty low bar for a good sales team. So it’s not surprising that so many firms focus on marketing and asset gathering. It’s not that they aren’t trying to outperform, it’s just that the incentive to grow assets under management is far more powerful and much easier to execute. And don’t forget that active management is a zero-sum game. We cannot all beat the market!
What sort of response have you had to this fee model? In particular, what if anything have your fellow fund managers said?
Actually the most interesting responses have come from clients. Because we refund fees, our expense ratios can actually be negative during periods of underperformance. We have had clients who look at their statements and ask if we’ve made a mistake!
Do you think we’ll see more fund managers offering these sorts of fee models in the future?
I certainly hope so. Not only is it a much better deal for clients, but I genuinely believe it’s the right thing to do. But given the powerful economic incentives in favour of charging flat fees regardless of performance, I think it’s safe to say that the conventional fee model is pretty firmly entrenched. Hopefully we can at least demonstrate that there is an alternative and perhaps encourage others to do the same.