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Orbis proposes changes to some of its fee structures

Hopes to better align fees with client experience.

One of the arguments in favour of charging performance fees on unit trusts is that investors will pay more when they can afford to – when the returns they are seeing are good – and less when their returns are poor. In reality, however, it doesn’t always work out this way.

Because performance fees are generally levied based on the returns over at least a three-year period, there can be a lag. Even though a fund might be going through a poor period, it could still be charging for performance generated in a previous cycle.

“So in a year where you see significant underperformance, the fee is slow to adjust down,” explains Tamryn Lamb, head of retail distribution at Allan Gray. “And when clients see that negative performance, they might ask why is the fee still slow to adjust, and why is the manager not experiencing the pain with me.”

This creates a disconnect. The point of a performance fee is that it is supposed to reflect what the investor is receiving in terms of value for money. If the fee remains high when investors are not seeing returns, that can lead to a lot of unhappiness.

Allan Gray and Orbis have first-hand experience of this over the past year. In March Moneyweb highlighted how the Allan Gray-Orbis Optimal Fund of Funds had charged performance fees, despite its relative and absolute underperformance.

Read: Questions raised about Allan Gray-Orbis performance fees

“If you’re really wanting to build client trust, we think you have to probably do your most work at the point when clients are feeling the pinch, at the weak part of the performance cycle,” says Lamb.

More reactive

For this reason, Orbis has proposed a change to the fees on most of its funds available to African investors.

The change is intended to make the fee structure more ‘reactive’, so that the fee being charged will more accurately reflect an investor’s current experience.

“This is not something we are doing in reaction to the last year of underperformance,” says Lamb. “We think this is a better fee through the cycle.”

The main funds affected by the proposed changes are the Orbis Global Balanced Fund and the Orbis Global Equity Fund, which will also then reflect in the Allan Gray-Orbis Global Equity Feeder Fund.

The first component of the new fee is that it will be meaningfully lower when the fund performs in line with its benchmark. At this level the funds currently charge 1.5%. Under the new structure, they will charge 1.1%.

However, the potential for Orbis to earn additional fees for outperformance will be significantly greater. Currently, Orbis earns around 12% of outperformance as a fee. The proposal is to increase this to 25%. The total fee charged will also be uncapped – both to the downside and the upside.

The real innovation that Orbis is introducing is a refundable reserve fee mechanism. How this works is that clients will be charged based on performance, measured weekly.

This shortening of the measurement period is what will make the fee more reactive, as investors will be paying for what they are seeing at the time.

Each weekly fee is not, however, paid immediately to the manager. It is kept in a reserve pool. In times of underperformance, clients will be refunded from this pool. Orbis earns its performance fee from the reserve pool over the three years following any outperformance, provided that the outperformance is maintained and the fees do not need to be refunded to clients.

Source: Allan Gray

Although performance from one week to the next is as good as random, and has little to do with the fund manager’s skill, Allan Gray believes the cumulative effect of three years’ worth of one-week periods will essentially be the same if performance was measured over the three years as a whole.

Practical impact

“Refundable fees are unique in South Africa,” says Shaun Duddy, product development manager at Allan Gray. “We think they will help clients remain invested during periods of underperformance because it will be easier to see that our interests are aligned with theirs.”

The result of this, according to Allan Gray’s calculations, is that investors in these funds will pay more in times of extreme outperformance – where Orbis delivers returns of 7% or more above the benchmark.

At all other times, the fee will be lower than under the current structure, with the potential that fees could be negative in times of extreme underperformance, provided that there is money in the reserve pool. If there is no reserve, the flat fee of 1.1% will apply.

Source: Allan Gray

Pros and cons

There are both positives and negatives here for investors. On the negative side, the proposed changes make Orbis’s performance fee structure far more complicated. This is one of the greatest criticisms of performance fees, that they can be extremely difficult for investors to understand.

It’s also challenging to compare against the fees charged by other funds, since no one else is offering something similar. It is difficult to know whether this is a good structure or not until investors have actually experienced how it responds through performance cycles.

On the positive side, it is a genuine attempt by Orbis to improve its offering, and to lower fees at times when investors are seeing underperformance. Whatever one might think about performance fees, one can’t doubt Allan Gray’s conviction that they are the best way to align clients’ interests with their own.

“A big part of the problem that we are looking to solve is that at different points in time, we want clients to see a fee that makes sense to them relative to what they have experienced,” says Duddy. “We think the additional complexity is worth it when that materialises over time. Among other goals, we want to avoid situations where clients feel that they have experienced disappointing performance but the fee that they see on the fact sheet doesn’t resonate with that.”

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With the current under-performance and the new fee structure, clients will pay more in fees due to the fact that there is no reserve in place. So what a fortuitous time to change the fee structure, when you coming off of 10 years under-performance.

The fact that Orbis still attract assets is a testament to their marketing campaigns.

For the life of me I cannot understand why investors should pay a fee on some arbitrary benchmark whose calculation can only be computed by an actuary. Who gives a damn about an internal benchmark? I want to compare Allan Grays performance against its competitors. I want to see how the manager is doing against all other fund managers that have the same mandate. If my manager is out performing the other fund managers in his peer group then I am happy to pay a performance fee. At the moment I am paying a performance fee to AG whose high equity balanced fund is lying 188 out a peer group of 196 ( year to date ) and 173 out of 186 funds over one year. The longer periods for this mandate and other mandates are just as poor.

Please show me one AG or Orbis fund with an ‘arbitrary benchmark’?

@Colson. Hmmm…perhaps it is not the benchmark that is arbitrary as some thought has gone into how the fund manager can create a benchmark which makes it money and cannot be properly understood by the average investor. Yes, that requires some application of the mind. Perhaps the performance fee itself is arbitrary. The fund manager asks himself the question ” how do I make more money than just my management fee” and the easy answer, without any thought, is ” just charge another fee “. So the performance fee is born. But think about it. Allan Gray is all about investing for the long term, time in the market they say, do not focus on short term performance, shortism is negative thinking. Then look at the performance fee. It is based on short term performance! Short term performance is transient! In the short term todays profits are tomorrows losses.In the interim performance fees were paid.If you are a long term investor invested with a manager who preaches the long term view do you expect the manager to charge performance fees on short term performance?

If you fall for this kind of nonsense you deserve to get fleeced. They WILL take your money – it is the miracle of compound expense, but it is also their nature and necessary to sustain being the most obscenely overpaid legal “profession” in modern existence.

Orbis and AG is desperately trying to pull the wool over our eyes with their fee structures to maintain their huge salaries, bonus and fancy offices.

Which planet are these people from. Now they make it even more complicated. Don’t they realise that I don’t have to place my money with them. There are fund managers out there doing a better job for much less.

Whee they should simplify and make costs transparent they make it more complicated.. and they pride themselves with that! Ha ha.. what a bunch of typical fund managers!

Foreign ETF’s has (and still are) outperforming by a country mile and has for many years. Cost much much lower.

Ten years of under-performance where the only people who benefited from Orbis efforts were themselves. Ten years!!

Allan Gray fails the smell test and every other test. Yesterdays heroes. SA funds too big ( due to slick and sleazy marketing). Offshore a bunch of nobody’s playing darts with clients money. Hopeless firm, hopeless managers!!

Look at Morgan Stanley’s performance, JP Morgan and avoid these overpaid non deliverers

How do they get away with this marketing gymmick! Is there no regulatory body that overseas this nonsense.

I’m another AG.. Orbis sucker. Dumped Orbis.. There are better index funds like Satrix Msci. Also better funds with the Nedgroup funds. Orbis is totally over rated..

“At this level the funds currently charge 1.5%. Under the new structure, they will charge 1.1%.”
“The proposal is to increase this to 25%. The total fee charged will also be uncapped – both to the downside and the upside.”

This will not entice one invest or to stay invested at Allan Gray`s Orbis!

The new complicated fee structure was obviously not designed to DISadvantage Allan Gray – the contrary, in fact.

There’s an old saying in the financial services industry – Any advantage to the client is purely coincidental.

Never ‘n truer word spoken in jest.

I like the fact that the fee payoff line is steeper and uncapped in both directions.

Not mentioned in the article is the fact that the benchmarks have also changed (from FTSE World to MSCI World after DWT). This will effectively lower the performance hurdle.

Active management comes at a cost. History suggests that long term out-performance by active managers is not persistent.

So what AG is saying is:

Heads we win, tails we win bigly.

Essentially unlimited upside on outperformance, but fully hedged on underperformance. What’s changed? Patrick, why don’t you call out this BS??

If fund managers do not have the skill to reliably beat their benchmark (if they did, they would guarantee it) the why should they receive an extra reward when they happen to so do?

Yup. The underperformance repayment limited to what’s in reserve. How long would that last? The 10 years they’ve had already? If they backed the process they’d remove that limitation! But hey, if you believe in reversion to the mean a good ten years might be in the future!!

It seems like some people commenting here forget that the firm, the employees and the portfolio managers invest alongside clients in the same funds at the same fees…

Sure they do…and the tooth fairy will be along shortly…

If you think they don’t then you must still believe in the tooth fairy.

For a potential client to understand the scheme, AG should market this with examples. If this had been in operation all along and a client had bought R1m worth of Fund X in 2000, 2005, 2010, 2015 then their R1m would today be worth for each start point, ABC vs XYZ under the old rule.

Surely they have that spreadsheet? I’d imagine it was the first question the executive committee asked before they approved the new plan????

Thts called back testing and they certainly have done the work. I really doubt they’d ever publish that but it sure as nuts guided the higher upside and the constrained downside.

Or, on the flip side : the new scheme is indeed an attempt to catch up with the reality that investors are not going to continue with the old model.

Yet, If they published the back test and it shows how much they have been overpaid it might ruffle some feathers among the gruntled (slow cooking frogs) that still remain.

It is time these “professionals” are paid and measured like other professionals. I do not pay my dentist based on my NAV. There is zero skill difference between managing R1b funds under management and R100b, BUT there is a 100 times difference in fees! The Account administration is nothing : it has to cost less than R5 per month which is what a transactional bank account costs.

Anyway, not my problem – just amazed and amused

The brave fin services co that offers purely performance-based fees, on a sliding scale, with one tiny yearly fee, will attract huge numbers of investors from other fs co’s including AG.Also offers a personal touch which is missing these days with all the electronic means of ‘communication’.

Disagree. I can see no need for performance fees in such an A type industry. We haven’t seen any fee reductions as the funds have gotten to gargantuan sizes. A small fixed fee is all that’s needed.

“Moral Harzard” is when the advisor stands to win big but the client carries all the risk. As the outperformance fee moves from 10% to 25% there is more incentive for the fund managers to take more risky punts in the hope of hitting it big with the next Tencent or Bitcoin.

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