Favourite offshore fund manager could buck trend on performance fees
Orbis would like revised charges to sync more closely with the periods that the funds beat the benchmark
The investment industry around the world is moving away from charging fees based on performance, but one of SA’s favourite offshore fund managers is bucking the trend with plans to introduce a revised performance fee in the first quarter of next year.
Orbis, the offshore partner of Allan Gray, is seeking regulatory approval for the changes and hopes to implement them early next year, Tamryn Lamb, Allan Gray’s head of retail distribution, says.
If approved the new fees will apply to Orbis’ Global Equity Fund, its Global Balanced Fund, Emerging Markets Equity Fund, its Japan Equity Fund and the Allan Gray Orbis Fund.
Investors in Allan Gray’s Orbis Global Equity Feeder and the Allan Gray Orbis Global Fund of Funds will also be affected by the new fees and fees on offshore allocations in the Allan Gray Equity, Stable and Balanced Funds will be adjusted.
Lamb says the proposed changes attempt to make the fee more responsive to short term out- and underperformance.
The flagship Orbis Global Equity Fund underperformed its benchmark, the FTSE World Index, by 11.6 percentage points, after fees and withholding tax, for the year to the end of September, Dan Brocklebank, a director of Orbis UK, said at a recent event for advisers using the Allan Gray offshore investment platform.
The fund’s longer-term returns are also below the benchmark: over 10 years to the end of September, the fund delivered two percentage points below the FTSE World Index each year for the period, Brocklebank said.
Orbis’s revised fees are very complex and I doubt any ordinary investor will figure out what they will pay because of the fee reserve.Gerbrandt Kruger, senior investment professional at Morningstar
In its proposed fee structure, Orbis plans to reduce the base fee it will charge regardless of how the fund performs, but the additional fee based on performance will no longer be capped. This means investors could pay higher fees than before when the Orbis portfolios outperform. Lamb says this will only occur when the fund outperforms its benchmark by 6% a year or more before fees.
Under the new structure fees will be charged more frequently, but these fees will be held in reserve and only one third will be paid over to Orbis each year, which means it will take three years to be fully paid.
The new fee is more geared to performance and force Orbis to take more fee risk, Lamb and Brocklebank say.
The fee differences would have resulted in a higher fee based on performance since the inception of the Global Equity fund; the fee would have been 2.4% a year instead of 2.2%.
However, over shorter periods like 10 years, the fee is lower at 1.2% a year as opposed to 1.9% a year, and over the past three years it would have been 1.2% a year as opposed to 1.8%.
Gerbrandt Kruger, senior investment professional at Morningstar, says Orbis’s revised fees are very complex and he doubts any ordinary investor will figure out what they will pay because of the fee reserve.
Lamb, on the other hand, says the complexity should be balanced against the additional fairness the fee reserve mechanism introduces and ensure investors are not prejudiced or unduly enriched depending on when they leave or enter the fund relative to its performance.
Fee reductions may seem like a win for investors, but the second-order consequences of reduced fees are that managers need to grow the amount they manage to compensate for the lower fees, Brocklebank says. He believes the manager could have grown much faster with lower fees.
The fact that the fee is no longer capped on all but the SA multi-asset funds introduces uncertainty about what you will pay, Kruger says, and he does not think the net impact will be a reduced fee.
However, concerns about high fees that could be incurred if good performance follows the manager’s recent poor performance have been addressed.
Lamb says there will be some interim arrangements to ensure the fee is fair as the manager transitions from the one fee structure to the new one. The transition will ensure that Orbis’ recent underperformance is fully accounted for and that the fees paid for any outperformance over the next three years are limited while the funds are recovering from that underperformance.
Orbis is expecting its funds’ performance to turn around in future. Brocklebank says the Orbis Global Equity Fund’s performance has been 10 percentage points below that of the FTSE World Index eight times before but its most recent underperformance is the most severe.
In the past, periods of underperformance have typically been followed by strong outperformance, the manager’s data shows.
James Downie, the head of institutional asset consulting at discretionary investment manager MitonOptimal, says Orbis’s revised performance fees are the best of a bad bunch. He does not buy the line that managers’ interests are aligned with those of investors when performance fees are charged, because most fees are aligned on the upside but not on the downside. The revised Orbis fee may be an exception, he concedes.
It might be worthwhile paying a slightly higher fee than that you would get from an index fund for the potential to earn market-beating returns, some of which you give up as a performance fee.Erich Potgieter, actuary and consultant at Willis Towers Watson
Asset managers get paid to do the best job they can according to the investment mandate, Downie says. If they do the job properly, they attract assets and earn higher fees. He says that around the world, more managers are moving away from performance fees as they are often unfair — with hurdle rates that are too low or fees that capture past performance that you may not have enjoyed.
Kruger says even formerly staunch believers in performance fees are introducing flat-fee options on their funds. But for Allan Gray and Orbis, performance fees are part of their DNA.
Coronation, for example, has introduced fixed fees on its US-denominated Global Emerging Markets Fund, its Global Equity Select Fund and its rand-denominated feeder fund. Coronation was charging clients using an investment platform to put money into the global equity fund a base fee of 0.65%, and the performance fee ranged from 0.3% to 1.9%. The new fee is fixed at 0.85%.
Kruger says that where performance fees truly align manager and investor interests with the right hurdles, are symmetrical and capped, they can be beneficial. But they are seldom structured like that.
Erich Potgieter, actuary and consultant at Willis Towers Watson, says performance fees can be structured appropriately for institutional investors such as retirement funds. But the administrative complexity and fairness to investors are harder to manage in unit trusts, where clients invest and disinvest frequently, he says.
Potgieter says he has seen a reduction in performance fee mandates in the institutional market over the past 10 years, as well as general fee reductions, as managers have struggled to beat benchmarks and compete with index-tracking funds. He says it might be worthwhile paying a slightly higher fee than you would get from an index fund for the potential to earn market-beating returns, some of which you give up as a performance fee.
When funds deliver good performance, it is human nature to pay less attention to the higher performance fee, but uncapped fees should be assessed to ensure they are fair under all potential performance scenarios, he says.
What the Orbis fee could mean
Performance fees typically start with a base fee that applies when the manager delivers returns in line with its investment benchmark. Orbis hopes to reduce this fee from 1.5% a year to 1.1% (including the fee to use the Allan Gray platform).
When a manager delivers returns above its benchmark or a predetermined hurdle, performance fees typically involve a split of this excess return between the manager and the investor. The split is called the sharing rate.
Orbis is currently taking 4% of the cumulative three-year return above the benchmark which equates to about 12.5% a year. Under the new performance fee it will take a 25% share of the return above the benchmark after the base fee is deducted.
The current fee is subject to a maximum fee of 2.5% a year and a minimum of 0.5%. The new fee will have no maximum or minimum except in the offshore portfolios of the Allan Gray Stable and Balanced funds where the old minimum and maximum fees will apply.
The new fee will be collected in a fee reserve. If the fund underperforms the benchmark, the fee will be refunded frequently at the full sharing rate of 25% until the fee reserve is empty.
This will make the fee what the investment industry calls fully symmetrical — fees collected on outperformance are refunded on underperformance at the same rate. Many performance fees structures do not fully refund fees on underperformance and are said to be asymmetrical.
The base fee is never refunded or reduced.
Only one-third of the performance fees will “crystallise” or be paid over to Orbis each year from the reserve, which means the manager will only be paid its full performance fees after three years and only after any fee refunds.
If the reserve is depleted due to fee refunds, the manager can only again take performance fees once the lost performance is regained.
Managers refer to this as achieving the high watermark.
Correction: November 12 2019
An earlier version of this article misstated that under the proposed fees for Orbis' Global Equity fund, investors would be charged a fee of 1.4% a year, over a three-year period. The proposed fee over a three-year period would be 1.2% a year.
Correction: November 13 2019
An earlier version of the story also misstated that Orbis was taking 25% of the cumulative three-year return above the benchmark. It is taking 1/25th or 4% of the cumulative three-year return above the benchmark.
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