How Dan came to Orbis
Well it's an absolute pleasure to meet you Dan Brocklebank head of Orbis UK. I'd like to talk to you first of all about your background. How did you come to Orbis in the first place?
Sure and thanks Ramin, good to meet you too. So my background, actually I qualified as a chartered accountant in the late nineteen nineties make me feel old here but I was always interested in the stock market and I watched from afar the tech bubble come and go. I was looking for an explanation for that and I was looking for a way to pursue that hobby of mine as a career and I came across Orbis in late 2000 and 2001 and what I discovered in the organization was an investment philosophy which explains how the tech bubble could happen but also at least as importantly in the organization I found a business that had been able to survive that period. Because it's easy to forget now how many organizations just didn't make it through either because they banged on their investment philosophy or because they were taken out and they went through difficulties. I joined in January 2002 so I've been with Orbis 15 years now. Most of the time I was part of investment team but as of last year I took over responsibility for the UK and so now I'm working with our retail and institutional clients.
How Ramin found out about Orbis - via YouTube!
Okay, so let me just explain how I came across your company. Okay yeah. One of the people who watches our YouTube videos actually said to me, "Yes, I only invest in passive funds". These are the very cheap tracker funds which have no kind of stock selection or human involvement at all they just track markets. "The only fund I have is with Orbis." Okay. "And the reason why is because they only charge you a fee if they outperform the benchmark". So you're the only active fund manager he could find which would do that. And I didn't believe it, I said no that's impossible. So I actually looked it up on your website, and it was true, I just couldn't believe it.
That's great, please send him our thanks, we're delighted to hear that that's resonated, and that's great to hear.
How Orbis Developed its Performance Related Fee
So how on earth did you convince the company that they should have this fee structure where you only get paid if you outperform?
Right okay it's quite a long story and I should first of all say that it wasn't me, it was not my idea, I haven't convinced anyone but I think, perhaps, just stepping back a little bit, the way we built Orbis has always been about putting our investment performance first that may sounds a bit perverse to some of your viewers or your readers but in the industry the overwhelming incentive is to get bigger because most people are paid as a percentage of the amount of funds that they manage.
So if you have a billion in your fund you earn 1% of that billion every year.
That's it. Whether you perform or you don't. Regardless of performance. So it's a bit of a headscratcher when you think about it. And so if you want to increase, in that situation, if you want to increase your revenues by five percent in a year you can either go to the fund manager people and say, "Well, I want an extra 5% performance out of your portfolio" and most of them will turn around and look at you and say "What on Earth? That would be crazy, I'd love that, that's what I'm trying to do!". Or you can go to your marketing team and say actually why don't you go hire another person and can you just sell a few more funds and maybe they'll say well "Could you start another fund, then, because this is selling very well at the moment". So it's much easier in the industry to grow your asset base than it is to generate that extra performance.
And our founder, Allan Gray, who set Orbis up in 1989, he was determined to make sure as an organization we would never lose sight of performance. So right from the outset all of our fee structures have been performance geared and with the goal being that we can only thrive as an organization and even survive very long term if we're generating value for our clients and that's what gets us excited within the organization.
So now how do we come up with the fee structure for the UK? Well we only started offering our services to retail investors in the UK about three years ago.
So this is Orbis Access which is a website so that anyone in the UK can buy your funds?
It's a direct website. It's the same firm as Orbis Investments it's just the website is branded at the moment under Orbis Access.
So before that you just sold directly to fund managers so fund manager for fund managers?
Well the vast majority of our clients before then were institutions: so pension funds maybe large insurance companies or endowments or very high net worth individuals and they came direct to us through a number of different ways but they're spread around 50 different countries so we really are a global company and we have a global client base.
So we said we'd like to do something in the UK because we think there's a need for our services. We can talk about that if you like. We wanted to try and say is there something we can do with the fee structure when we set up the vehicles in the UK that might be a real differentiator for us to try to take this principle of aligning our interests with our clients to the next level. And as you mentioned in your in your introduction the question there one of the trends we see at the moment is a significant push towards passive investing, tracker funds, and actually, hands up and say, I think, for most people that's a very sensible thing to do.
You can't say that!
Well I can! Because it is! I can't deny the logic. On average on average fund managers are the market. It's a zero sum game fund managers are dealing in. And active managed funds must charge higher fees than passive funds because passive funds are basically a computer running in the background. And so on average the experience of investors in active managed funds must be less than the experience investors in passive funds and this is the dilemma we're all faced with. So we recognize that this shift is going on, in many we think it's sensible. At the same point of time we passionately believe that there's a role for active management. There's an ability of certain fund managers thinking correctly to add value to their clients over long periods of time. We've been at this for 27 years now and the global equity fund which is our flagship fund has outperformed, after all fees and expenses, by a bit less than four percent per annum. So that makes a big difference. It doesn't sound like much. But it makes a big difference when you compound that over time.
Four percent long-term is a big deal.
Four percent per annum over 27 years makes a massive difference. So we recognize passive investment is growing but we passionately believe in active management and we think that our philosophy most importantly but also the way we build the firm has been set up deliberately to ensure we can keep doing that. So we said well how can we how can we put something in place that helps bridge that gap for UK retail for potential investors. And so the fee structure we came up with in essence produces the situation which is that if all we do is perform in line in the benchmark, produce the same returns as a tracker fund, we will not get paid a fee. Our fee is performance only. If we do outperform then we share in that outperformance but if we then subsequently underperform those performance fees are refunded. And as you wrote in your blog it's a little bit like the seven fat years and the seven lean years. So there is a stabilizing mechanism in that fee structure. But the most important thing is that it aligns our interests with those of our clients and clients can know that we can only do well if they do well. And that's the thing that we feel most passionately about.
So your incentives are aligned with those of your investors which is very unusual. And also you talk about it as a symmetric fee structure. So symmetric means that if you make a gain you get a higher fee you make a loss, or if you underperform the benchmark rather, you lose that you lose your fee.
Yes. So there are a couple of aspects, angles, to it which perhaps if you just want to get a little bit more detailed. Firstly active funds tend to charge fees or pass on expenses in a number of different ways. The first thing to say is that our ongoing charges ratio is zero percent. As a manager we've chosen to absorb all of the costs of actually running the vehicles and the legal costs, the admin costs. Those are typically passed on to investors in those funds. So actually if all we do is track the index we'll be out of pocket. So it's a little bit more extreme than I mentioned a little bit earlier.
So firstly we absorb that so the ongoing cost generally is zero percent. If we outperform, in exchange for that, if we outperform we share in fifty percent of any of that outperformance. So if the market stays flat and our fund goes up by, let's say, four percent two percent will get charged as a performance fee. Now, importantly, it doesn't get paid to us straight away it gets paid into a reserve which sits in between us and the clients. If in the second year we subsequently underperform and that's assuming this year we underperform by 2% so maybe the market goes up by two percent and we stay flat. Then half of that underperformance so half of 2 percent i.e. 1 percent will flow back from the reserve into the fund to refund clients. So at the end of the period we would have outperformed by one percent but there'll still be one percent in the reserve.
Now I've simplified that to a certain extent because we can crystallize some fees when there is some fee in the reserve but we cap that crystallisation rate. And what that means is that our incentives, importantly, are not just to outperform in the short term but to outperform over long periods of time and to sustain that outperformance. Because only if we can generate performance over long periods that we can actually crystallize those and get paid those performance fees in cash.
The Reserve Recovery Mark
But there's also this thing about you don't take essentially get paid out of this slush fund, this kind of reserve fund but if you go below a certain high water mark you don't take, you don't get paid.
So what happens is if we if we outperform or let's just say from day one if we underperform then we wouldn't charge any performance fees and we have to recover that underperformance before we can start charging performance fees against it. We call that a Reserve Recovery Mark that's reasonably common, the idea of a high water mark is reasonably common in the industry and what it does is it it prevents us charging for the same outperformance twice. So it's kind of double charging. That's right.
How do you hire fund managers that can consistently pick winning stocks?
So how does this feed through to the actual compensation of your managers and how do we find managers who have the magic touch which can actually generate outperformance, or "alpha" as we call it? Yeah. But it's almost like a faith now isn't it believing in alpha believing in outperformance. It must be really hard to find fund managers who can consistently outperform over the long term.
It is, it is. And I would say I think it's harder for people to select managers than it is for managers to select stocks. Because when you're sitting there thinking of stocks you've got a whole load of audited information that goes back often for twenty, thirty, forty years. You can get and test the products out. You can see it in real time. With managers you're sat there and you don't always get all the information you want or should have. So it is a difficult job selecting managers. And the way we approach our investment team is actually driven by what our long term mission is as a firm. And our long term mission is to empower our clients by enhancing their savings and wealth. And for most people when they're saving and investing one thing to recognize is if we're going to do that really well we have to do that over long periods of time because we're really in the business of harnessing compound interest. And compound interest is a very very powerful force, it's one that humans often underestimate because our brains tend to think in linear terms.
But for us to do that as an organization continued over long periods of time, and the time frame is longer than most people's investment career. And so we need to think not just about producing those investment returns this year, next year, even five years down the line we need to think fifteen, twenty years down the line. So the Global Fund today is a product of six specialists or six people's stock recommendations. But our investment team as a whole has about 45 people in it and it's way more than we need at the moment.
And really what we're doing is bringing people into the investment team who have a passion for stock picking, who we think might be good and most importantly they don't have the proven expertise but they have the character sets that we think are likely to be successful long term. They work within the investment team and they actually make recommendations but those recommendations don't have any impact on the actual clients' portfolio. And you may say what on earth do you do that for, that sounds ridiculous, you've got all these people working away... but what it gives us and the most important thing, the reason we do it, it gives us a rich dataset and we can see all these people who joined our investment team, we can assess them over long periods of time and say are they demonstrating any skill in terms of making investment recommendations and what that enables us to do is spot the next generation of stock pickers.
And when we find somebody we can gradually give them more authority, more responsibility and in that way we're looking to build a team that can organically, sort of replace itself over long periods of time. So we have the informational edge because we're sitting internally we can see why they made a recommendation. Were they right and were they right for the right reasons? You can be lucky in investing! Were they right for the right reasons? And when we find those people we're very excited we can give them a great working environment and lots of responsibility in future.
To use a sporting analogy, everyone loves a good sporting analogy, much of the investment industry is run on what I call the Tiger Woods Model. Firms are built around a star player. And there's nothing wrong with that whatsoever. There are some extremely talented people out there and Tiger Woods is an extremely talented golfer.
Or we could say Woodford.
I'm not naming any names. This is not about naming names. This is an approach towards building a firm. And Tiger Woods was fantastic at golf but as we all know his career came to rather an abrupt end for reasons that I don't think anyone could have, from the outside, could have predicted. And so investors in a fund that's run like that have this dilemma of going, "Is this person genuinely enduring?" We liken our approach to a team like Barcelona Football Club. They may not always be top, they may not be the best football club in the world every year. But they are consistently very very close to the top and they put a lot of effort in identifying young people with potential and then drilling them and teaching them the Barcelona Way so that they can develop into the superstars of the future ant that's what we're trying to do. So for us it's a team-based approach rather than individual approach. We think it's best for clients and it's the way we think we're most likely to be able to harness that that magic power of compounding over long periods of time.
Transparency about transaction fees
And I just couldn't believe it when I saw your website because there's a little box that talks about fees, and one of the fees that you mention is the transaction costs. Now there's no other fund manager I found which is that honest and that transparent.
I'm surprised you say that I haven't gone round and looked. I'm sure there are some, I can't believe nobody else puts it out there. So, just to be clear for your viewers, the transaction costs are the costs that we would spend on clients' behalf in buying and selling the shares in the fund. Now I mentioned earlier that as a manager we bear some costs of running the fund. We don't bear the transaction costs. They are part of the purchase price of a share in our mind. But we need to think about it in the context of our fee structure because what's happening here is that we have the ability the authority to incur expenses on behalf of our clients in buying and selling the shares. But our fee structure is driven by the performance that we generate and because of that sharing ratio it basically means that we are sharing, we are paying, 50% of all of those transaction costs because each of those transaction costs reduce the return that the client's going to make. So a lot of ink has been spilled over transaction costs and I suspect it's going to feature in the FCA's report. I personally don't think that layers and layers of regulation will fix the problem because smart people will always find a way to do something silly or creative. The key thing as a client that I would like to see in any fund is to see that my interests are aligned with that fund manager. Because if I know that the investment manager's interests are aligned with mine I know that they are directly incentivized to making sure not that they pay zero but that they get good value for money. And value for money is a critical thing. I think it's the aspect where our industry has struggled the most and when you pay fixed fees regardless of performance it's very hard to say you're always getting offered value for money. That is what we're focused on and our fee structure means that we are incentivized to get the best value for money out of those transaction costs.
Will other active managers adopt a performance-related fee?
Okay, so maybe one thing to talk about finally is Vanguard because I'll probably be talking to them later. So obviously they've just hoovered up a huge amount of capital because they track they track indices very cheaply so they've done an incredible job at keeping costs low and a lot of money has flowed into their company as a result so as you say assets under management is how much profit you make, so the bigger your pot the more money you make. So as an active manager competing with that flood of money coming out of active management do you think other companies are going to adopt your fee structure?
I can't speak for other companies. I have heard a few people mentioned that the use of performance fees is going up and anecdotally we've had some inquiries from other managers but I don't know what other people are going to do. What I would say is firstly I have a lot of respect for Vanguard I think it's a very impressive firm but I don't think we I wouldn't see us in competition with them. They're offering a fundamentally different product. They are saying we will get you the average market return at the lowest cost possible. And, as I said right at the beginning, I think for many people that's a very sensible strategy. We think we can produce superior performance when measured over long periods of time. Not consistent, but over long periods of time we think we can outperform. And we're happy to be paid only if we're successful in that regard. So in many ways I think our approaches are very complementary and blending a core of your portfolio in passive tracker funds with one or two highly active, long-term focused investment managers to me makes a great deal of sense.
Long term partner incentives
Okay it's almost like the old building of cathedrals isn't it? The people who actually work in your company they never actually see the completion so when you think over this very long period of time is it's almost like you're building a career, building something which you'll never see the completion of because it's going to go on forever.
That's an interesting way of thinking about it. I would just say when you work for an organization that's been around for 27 years you recognize that everything we do today we're standing on the shoulders of the people who came before us and you know our goal at Orbis is to build an enduring organization. And the way for people to be partners in the business, people who share in the profits of the business, we are all incentivized not just on how well the firm does while we're here but for a trailing period after we've left. For six years after we've left. So my incentive is not just to make sure we do a good job today but when I leave and when I come to move on I've left the firm in the best possible position for clients and for the people who come behind me. Yeah that's a good analogy.
Well, it's been a real pleasure. Thanks very much for your time Dan.
Thanks Ramin.
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