Kurtosys spoke recently with Dan Brocklebank, head of UK at Orbis Investments. He walked us through the tainted history of performance fees and how their structure can mitigate the too-common conflict of interest between asset manager and client; he said the door is open to working with new tech partners, and explains the group’s focused ethos.
Tell me a little bit about Orbis and what you stand for as a business.
Orbis was founded in 1989, the second fund management group set up by a gentleman called Allan Gray. We are a privately owned organisation, with about 400 employees in 10 locations around the world, 170 of which are based in the UK. Alan founded his first investment company in 1973, Allan Gray Limited, which is now one of South Africa’s largest privately owned investment companies.
What Orbis stands for is to serve our clients, empowering them by enhancing their savings and wealth. For nearly 30 years we’ve been successful in doing that, importantly, not every year but we have meaningfully outperformed when measured over the long term. Looking forward, we think we can continue to do that by applying the same long term, fundamental and contrarian approach to investing that we have used since we set up and that our sister company has used since 1973.
The term ‘contrarian’ means different things to different people. How do you define that and apply that into your investment strategies?
If you want to outperform you have to be different, which means having a different set of views about some variable, about something that is relevant to the company’s future and its valuation, than what is priced in by the market.
Classic contrarian thought is that the markets are excessively pessimistic, and you think sentiment will improve.
But you can also be contrarian – and this is where we are probably different from typical value managers – by saying: “The market thinks that Facebook is going to grow at X% per annum. We think the market is being too conservative. We think that Facebook has a very strong established moat (admittedly, with some near-term challenges on the regulatory front), but ultimately, it’s going to be able to grow its profit faster than the market expects. As a result, when expectations catch up with our view on Facebook prospects, the share price will rise to reflect that different reality.”
But at the end of the day, being contrarian is just about being different.
Orbis appears to be raising its game in the UK retail space. Why is now the right time to do that?
We’ve actually been in the UK since 1990, with a large number of employees based here, but for most of that time our funds have only been made available to large, predominantly institutional, investors. Five years ago, we launched an Oeic vehicle with two mirror strategies of the Orbis Global Equity and Orbis Global Balanced funds, available to investors for a minimum of £1.
As part of that, we have also provided individual clients with the opportunity to invest with us directly via Orbis.com and hence avoid a layer of platform or adviser fees.
The reason we have done this is not taking a short- or medium-term view of the market. If you look back over multiple decades, individuals are increasingly having to take on responsibility for their own financial futures. Rather than serving clients through their defined benefit pension scheme, we realised we needed to offer something for people who are, essentially, now out on their own looking after their financial future. When we thought about how best to do that, we knew we wanted to make it simple, accessible and cost effective.
In having only two funds available, while remaining very focused, that must bring with it a lot of pressure to perform.
We believe if you want to be successful, you’ve got to be focused! Take Roger Federer, one the greatest tennis players ever. I don’t recall ever reading too much about him practising his golf swing.
We start by thinking about what clients want, not what suits us as a business. Most ordinary people I speak to complain there’s just too much choice when it comes to picking funds.
It’s not easy to decide between an emerging market mega cap, or a small cap European fund. It’s a real problem because for most people, too much choice is a turn-off. And I often wonder if it’s one of the reasons why people are reluctant to engage with the industry.
We deliberately chose to offer a limited range of funds and just focus our efforts on trying to make those as successful as possible. For us it means we are less diversified, it is a deliberate choice and it’s one that we’re comfortable with.
You’ve been fairly vocal about the conflict of interests that appear with the fee structures of the UK fund management model. Tell us your frustrations and what you think needs to happen to induce change.
The vast majority of the industry charges on the basis of fees as a percentage of assets under management – some people call it flat fees or ad valorem fee. That structure has some advantages, it’s simple and it’s predictable both for the manager and for the client. But that simplicity brings with it two big problems.
First, it means clients pay fees regardless of the performance they receive from the manager. Basically, the deal ends up for the manager as being ‘heads: we the manager win, tails: you the client lose’. I think that’s another reason why many investors are sceptical about the industry.
The second problem with this prevailing fee structure is that if you put yourself in the shoes of the owner of an asset management firm, to increase profit of their firm – not an unreasonable goal if you own a business – the fee structure provides an often overwhelming temptation to grow AUM as much as possible, even if that comes at the expense of performance.
Or perhaps it just means launching a bamboozlingly large range of funds so that the marketing people always have something to talk about.
We start from the assumption that after a client has invested with us, we want to maximise the chance that, whatever the performance turned out to be, our fees represented value for money.
Let’s bring that to a non-financial example.
Think about value for money for a second. If you go shopping, you can stand in the supermarket and you know in advance how much you value the fact that your vegetables are organic, and as a result, whether you’re happy to pay the premium price for organic vegetables over the standard ones.
When it comes to selecting funds, nobody knows in advance what extra value the manager will deliver above and beyond what they could get just from a passive market.
When we launched the UK Oeic, we decided we could only charge a fee if we added value for the client. So, we bear all the costs of running the fund. If all we do is perform in line with the index, clients will be better off investing with us than in a low-cost tracker fund because even tracker funds have some costs.
It is true that our fees can be higher than average, but only if we deliver exceptional performance. Most people I speak to don’t have a problem with that concept, provided that we also don’t charge fees if we underperform. That’s the nature of the fee model that we have set up.
Performance fees can often be quite divisive – eg the hedge fund space have taken a lot of flack over the years. How do you decide what fee levels are fair?
Performance fees have a bad reputation in the industry because, frankly, they were abused. The so-called ‘2 and 20’ model – is much more accurately described as a large fixed fee, plus a bonus for the manager in good years.
The huge flaw with this model is that fees paid during a year of good performance were paid straight to the manager, but if the manager subsequently underperformed the client bore all the losses for that underperformance.
What that means is that clients were effectively giving a free call option to the manager and incentivising them to take undue risk. It’s no surprise that you saw some incredibly blow-out performances, followed by a number of well-known funds completely tank afterwards.
It’s important to note the fee models are evolving, which is partly driven by technology. But performance fee structures like ours have a refund mechanism, which means the fees charged are not paid directly to us. We have to generate and sustain that investment performance for those performance fees to be paid out and that’s a critical difference.
What changes is the business making to adapt to using new technologies (robotics, automation, AI etc)?
I think there’s a lot of talk about technology now. The reality is that we’ve always used technology from day one, either to combine or efficiently analyse the price data or valuation data. About 20% of our 400 employees are IT professionals and we’ve always invested in technology across all aspects of our business, from the coalface of research through to making our middle and back offices as efficient as possible, and nothing’s really changed there.
The rules of our game are not fixed. If you play a game of chess or football, the rules won’t change throughout the game. But investment markets are much more like weather systems, they are highly dynamic, so technology is playing an increasing role in supporting our fund managers go about their research process.
But in our view, we are a long way off being able to replace fund managers with technology. There are forms of trading where technology can make things more efficient; those based on speed, timing, and short-term trading.
Technology cannot see the fact that a company is a fraud, for example, but it might help you analyse the data that helps suggest it might be a fraud.
The way we outperform is through a long-term focus on how businesses are evolving, being willing to go into unpopular areas of the market and being patient and focused on the long term. I think there’s always going to be a human element to that.
How is the business targeting the next generation of investors?
It is something we’re continuing to think about and work on and, in developing our direct platform we believe that, for those people who are happy to go it alone, we have built something that I think enables them to get a significantly better deal than the rest of the industry operates.
The general fintech landscape is highly evolving and it’s something we’re keeping a watching brief on. Our mission is to help clients invest direct and if we can find avenues or partners to work with in future, we’re certainly interested in having those discussions.
We recognise that, with open banking, the landscape is changing. And with 20% of our staff across the business being IT professionals, we do think the future will have some form of technology enablement.
But our first priority is to get established in the UK and have people understand our history, our process and our investment philosophy. But I think it’s genuinely fascinating and if we can find a way to work with like-minded groups who recognise the value in what we’re doing, we’re definitely interested.