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Questions raised about Allan Gray-Orbis performance fees

The Global Optimal Fund of Funds has charged for performance despite sustained weak returns.

Allan Gray and its sister company Orbis are strong believers in performance fees. They contend that they are the best way to align their clients’ interests with their own.

However, anyone looking at the recent performance of the Allan Gray-Orbis Global Optimal Fund of Funds and the performance fee it is charging would be justified in asking how this is true in this instance.

To the end of February the fund was the worst-performing unit trust in the global multi-asset low equity category over six months, one year, three years and five years.

Source: Morningstar – note that the Allan Gray-Orbis Global Optimal FoF does not have a 10 year track record (click to enlarge)

Measured in rands to the end of February, it returned 0.9% over the previous 12 months, and 3.6% per annum over the last five years. Those numbers are however helped by the weakening of the local currency. In US dollars, the fund’s return over those 12 months was -15.3%, and over five years -1.8% per annum.

Overall, that paints a picture of a fund that has not delivered much for investors. Yet its total investment charge over three years to the end of December 2018 included a performance fee of 0.8%.

Short term vs long term

The reason for this is that the fund outperformed over 2016 and 2017 and over a few months at the start of 2018. This has entitled it to charge the performance fee, even though over three years it has materially underperformed its benchmark. It has not, however, levied a performance fee since February 2018.

Allan Gray-Orbis Global Optimal Fund of Funds to 28 February 2019
  Fund annualised returns Benchmark annualised
  ZAR US$ ZAR US$
Latest 5 years 3.6% 1.8% 3.9% -1.5%
Latest 3 years -3.9% 0.3% -2.9% 1.4%
Latest 2 years 0.4% -3.2% 6.3% 2.5%
Latest 1 year 0.9% -15.3% 16.1% -2.5%
Year-to-date (not annualised) -4.3% -1.6% -2.8% -0.1%

Source: Fund fact sheet

As the table above shows, investors have paid a performance fee, despite the fund’s meaningful relative and absolute underperformance.

Source: Morningstar

Orbis however remains resolute that its performance fee structures are in the best interests of its clients.

“Performance fees are an integral part of how we have run Allan Gray and Orbis,” says Tamryn Lamb, head of retail distribution at Allan Gray. “They are central to our message that our interests are firmly aligned with those of our clients. We don’t think we should do well unless our clients do well over the longer term.”

Is the fee asymmetrical?

However, there is an argument that for a performance fee to be truly aligned with clients’ interests, the asset manager shouldn’t only be sharing on the upside. They should share in the pain on the downside as well.

This is the case with most of Allan Gray’s funds. For example, the Allan Gray Equity Fund reduces its fee if the portfolio underperforms its benchmark.

In the Allan Gray-Orbis Global Optimal Fund of Funds, however, the firm earns a fixed annual management fee, regardless of the return. Orbis therefore shares only on the upside, and loses nothing on the downside.

“The current fee structure is asymmetric and in favour of the fund manager,” argues Gerbrandt Kruger, senior investment analyst at Morningstar. “The fund has a relatively high annual management fee of 1% plus Vat, and, in addition, charges a performance fee when the fund outperforms bank deposits over a year. In our opinion, Orbis and Allan Gray should find a more appropriate benchmark for the fund and one that ensures alignment between themselves and their investors.”

Orbis however argues that the benchmark is appropriate because the fund aims to deliver a cash return, plus or minus its ability to deliver alpha from its equity holdings. This is despite the fact that over the last few years this has been an unchallenging benchmark to beat, given that cash deposit rates in the US and Europe have been close to zero, and sometimes negative.

The firm also believes that the management fee is not excessive, given what is involved in running the mandate.

“What we are trying to achieve is a fund that delivers an uncorrelated, diversified return over the long term, irrespective of the market environment, and that can outperform cash and bonds,” says Lamb. “So we think a higher fee than for a money market or bond fund is justified. We are doing the same amount of work in this fund as in our equity mandates, which charge similar base fees.”

But is it fair?

Yet, in a period where the longer-term return has been so poor, and the benchmark has presented a relatively low hurdle, is it still fair to charge for performance? Wouldn’t it be in their clients’ best interests to acknowledge that it isn’t appropriate under the circumstances?

Lamb doesn’t believe so, as she is concerned about the message this would send.

“We know that the performance has been disappointing, and that it has tested clients’ patience,” Lamb says. “However I worry that if we waived the performance fee component temporarily, it would say that we think we did something wrong in the underlying strategy – that this fund made a big mistake, we eroded capital and we don’t think it is going to return. If we chop and change our fee structure when we underperform, I think clients would lose faith in us.”

Precedent

There is however precedent for this. Investec Asset Management suspended the performance fee on the Investec Value Fund in 2015 when it had experienced a sustained period of underperformance. The firm took the decision that, under the circumstances, to charge a performance fee for short term relative outperformance would not be appropriate when the longer term returns were so disappointing.

For Lamb, however, this is not their preferred option. She believes that putting performance first, and being focused on providing value for money and charging for value added, have been hallmark principles for how Allan Gray and Orbis have always operated.

“In saying that, we continually look at our structures to see if they should be improved,” she says. “We do this on an ongoing basis, and we aim for improvements we make to be made with a longer-term view in perspective – not simply in reaction to short-term performance.”

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COMMENTS   27

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Wait for the old trick : change the benchmark until you find one that you can beat

Why do people still bother – index/tracker and go.

Exactly. No investment that I have ever had through any adviser has ever beaten indices over a 5 year period.

It’s a BS industry that cons the man on the street.

Such an old school way of arguing. Watch investors pulling out in droves. People are much b etter informed these days and is not that brand loyal anymore. Performance is all that counts.

Thank you your Honour, I rest my case that the majority of these organisations are nothing but greedy wolves. Educate yourself from a financial perspective (www.justonelap.com), and DIY your own investments. It really ain’t that difficult, just pull your finger.

Between being a client and a fund manager, the latter is by far the more lucrative option. You never make a loss on your fees. The client isn’t so lucky, Asking fund managers to justify their fees will lead to a lot of “umms” and “aahs”. A friend and I have been running a comparison . In 2003 we invested the same amount in separate funds to compare growth over time. You know, “you have to be in it for the long run”. and other furpies you when your investment has experienced a negative growth. The same rearely happens to management fees. If was a once-off lump investment with no further contributions. Returns are re-invested. His fund charges higher fees and performs OK. Mine charges lower fees and performs OK.

After 15 years of watching the investment, the difference is cosmic. My investment has outgrown his by three orders of magnitude.

Simple modeling in excel could surely have saved you 15 years?

You raise a fair point however the optimal fund is a fairly different fund from that of the other Allan Gray-Orbis funds. It represents more of an alternative building block fund that targets cash returns. Anyone who has been in an Allan Gray-Orbis funds (with the exception of the optimal fund/s) for the last 10-15 years has been more than happy with their performance regardless of the performance fees.

Hopefully this article doesn’t paint all of the Allan Gray-Orbis funds with the same brush in regard to the performance fees.

For the South African focused funds I suggest you look at recent returns. For all periods returns have been diminishing sharply.

Allan Gray Equity (TER: ~2%)
Feb 2009: AGE 10y return: 26.6% p/a
Feb 2014: AGE 10y return: 19.6% p/a
Feb 2019: AGE 10y return: 13.4% p/a

Recent 5y return number is around 7%.

Same for Balanced fund – scary for all those people looking forward to or in retirement.

The Orbis Global Equity fund (TER: 2%) is under-performing it’s benchmark for all periods upto 10y.

AG/Orbis argues that this under-performance comes with the territory of being an active manager. The investor needs to decide whether they can live with this.

Isn’t that the issue with a house view… when the house is wrong, all funds underperform

Finally a journalist that’s taking a look at performance fees!!

These fees are insidious and nothing more than daylight robbery. Surely, if you charge a flat fee on the value of the asset, your interests are aligned with the investor? If the value increases, your fee increases, if the value drops, so does your fee.

For the record, we will not include any fund that charges a performance fee in our fund of funds.

Agree.

I can’t find one justification for performance fees, the more so in an industry with so many A-type, “have to perform” people staffing it. What I want to see is fees come down as the funds grow in size.

Run the numbers for any of the big funds… e.g. AG Balanced Fund was R162.6bn at end Feb (source fund fact sheet) and TER for a 1 year period is 1.57%. That equates to income to Allan Gray of R2.39bn A YEAR. What does fund management cost? A swish office? At most a few tens of million for a big fund and big offices…

They were doing well when the fund was a few billion in size. They are doing ridiculously well now.

I don’t think one fund in SA has decreased fees specifically as it got larger…

Many investors are not aware of the behind-the-scenes workings of performance fees.

If a manager charges a performance fee when their investment return exceeds the annual return on a specified benchmark, then one would except no performance fees to be charged in a year where the manager does worse than the benchmark.

This is, however, not the case.

In practice, the manager will measure his portfolio’s annual return on a DAILY basis against the annual return on the benchmark. Some days the manager’s investment returns will be better than the benchmark, and some days the manager will lag the benchmark investment performance. On those days that the manager outperforms the benchmark, a performance fee will be charged. If the manager outperforms the benchmark only 1 day in a month but underperforms all the other days, then the manager will still charge a performance fee in that month. However, it is very likely that the manager’s performance for the month as a whole will still lag the performance of the benchmark for the month.

Investors should therefore treat managers who charge performance fees with the utmost caution, as you can still incur performance fees even though your manager’s investment performance is worse than the benchmark.

If they charge performance fees during periods of outperformance then they should refund fees during periods of under performance.

They are quick to take credit for any good performance. But they never take responsibility for underperformance which is always blamed on external factors.

I think performance fees can only be justified for superior performance compared to other funds in the same category rather than just beating a benchmark which is easy to do in a bull market

Why bother with supporting those who charge performance fees,when anyone who can read can run their own portfolio at a fraction of the costs the ‘advisors’ charge. Index tracking funds are the answer, giving above average returns and dividends,and you don’t get parasitised.

“Investec Asset Management suspended the performance fee on the Investec Value Fund in 2015 when it had experienced a sustained period of underperformance. The firm took the decision that, under the circumstances, to charge a performance fee for short term relative outperformance would not be appropriate when the longer term returns were so disappointing.”
According to the Feb factsheet for the Investec Value fund, although the fund is outperforming by 17.5% over 1 year, it is UNDERperforming its benchmark by 2.3% PER YEAR over 3 years and UNDERperforming by 1.9% PER YEAR over 5 years and yet I see they saw fit to charge 1.49% performance fees over the past year, taking the total expense ratio to 2.58%? This is highly unethical. Unless measured since inception, performance fees do NOTHING to align investors interest with managers. What a joke.

A few points to consider

The 1% mgt fee is there to keep the lights on. It is very hard to run a stable business if your fee income is totally reliant on the performance fee. Think of sales people they make a basic salary and commission based on sales results. Should the 1% fee be tiered as FUM grows I would contend yes.

They don’t share in any of the downside comment I would contend they are no longer getting performance fee that’s sharing in the downside in my view.

Short term outperformance versus long term underperformance can be easily counteracted by a high water mark. Thus if you are down 30% in Year 1 and benchmark down 25% and then Year 2 up 15% and benchmark up 10% you still need to catch up performance from prior year despite outperforming in the current period.

Benchmark I agree you can’t have a cash-based benchmark when you are using equity investments to deliver cash + return. Have an absolute number say 6% or a relevant equity benchmark.

The Orbis Global Equity Fund has also underperformed its benchmark over 5 years and has a TER at Dec 2018 of 2.11%. The fund’s assets are $6.3bn or R90bn. They charge a 1.5% basis management fee, which equals R1.36bn per year. Surely this is enough to cover their running costs? On top of this they charged a 0.5% pa performance fee, equal to another R453m yet underperformed for the last five years.

I’ve been invested with Allan Gray fo 20 years and always had respect for them. Orbis, I’m not so sure of. Every time I’ve invested with them, like now, they preform well for a few months and then disappoints. I’ve been waiting for some market insight or explanation from them but nothing. I though such under performance to the benchmark would justify some special note. Guess while they get their fees they care less about us losing money.

“Is your money ready yet? Noooo …..”

Will you get your original investment back eventually?

Maybe …

To investors who are complaining, who exactly ‘forced’ you to invest in the fund and if you are unhappy ‘why don’t you find another fund. If it is all about lower fees there must be numerous funds out there for you to select. You knew the fee arrangement when you invested (I presume) so why complain now? Some investors need to grow up and stop being babies because there is enough choice out there for you to quite easily change funds in a matter of days. Many forget AG how been around some 44 years which who don’t do in this industry unless you are very good. Absolutely no one is forced to invest in funds whose fees they find unacceptable.

Thanks Patrick for revealing this.

I’m curious? What similar funds comparable to Orbis Optimal Fund of Funds are there in South Africa? Low offshore equity exposure but in rands.

I’d like to do some comparisons. Cheers

Nedgroup global cautious. Sanlam has one i tbink.
Investec, coronation and prescient all have global income funds.
Check on fundsdata they have a category that lists the global low equity funds.

But the optimal funds are not straight low equity balanced funds, its actually hedged equities using derivatives (not a hedge fund, note) so they sacrifice upside by trying to restrict drawdowns should there be a crash or correction.

Its actually quite unique in what it does and the actual performance review needs to take into account how well it protects capital losses compared to peers, not just what its total return is.

Its not for everyone though. I have some investment in the SA optimal fund but globally, it doesnt fit my needs.

The market is too perfect these days for an industry of hyenas. Its difficult to beat the benchmark consistently. Rather go long index funds( which are super liquid) leverage them at say 30%( offshore in USD or EUR funding costs not in the banana republic currency) -you will beat the hell out of most fund managers for minimal extra risk.

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