Post: Review of Orbis: Active Management With A Radical Fee Structure

Review of Orbis: Active Management With A Radical Fee Structure

This is not a recommendation. If you want financial advice tailored to your circumstances seek independent financial advice. We are independent and receive no payment from Orbis Investment Management (or Bob Bowron) for writing this review.

This is a story about just rewards. On the way we will get to meet Bob Bowron. Bob fixes cars. He has a workshop in the middle of the Buckinghamshire countryside where he performs mechanical alchemy on a daily basis. He has the easy air about him of someone who is great at what he does and enjoys it too. Here he is with one of his wards enjoying the springtime sunshine in Flaunden.

Bob Bowron with Shades

Let's see what Bob does at Bowron Motorcare. Here is a before and after picture which shows the miraculous transformation that he can perform:

Before Bob

Before Bob's Magic

After Bob

After Bob's Magic

​Being able to take a rusting wreck and transform it into a mahogany panelled, chrome-trimmed thing of beauty is an art. Bob really earns and deserves his fee for the service he performs. That's why people seek out Bowron Motorcare from all over the county and beyond in the expectation of everyday miracles on their vintage cars and German luxury wagons.

Imagine for a moment that Bob changed his business model. Let's say that instead guaranteeing that he would turn your rusting wreck into a shiny thing of beauty he gave a 25% chance that the car would be fixed. Sometimes the paintwork might be a bit shoddy, and there may be some rust left in some patches. But rust patches or not you'd still have to pay him the same amount. Would that business model work? And yet that is exactly how the active fund industry works at the moment.

​Should we reward failing fund managers?

The majority of the fund management industry assumes that you will pay them whether they fail or succeed.​ For most active fund managers the deal is that you pay them an annual fee based on the size of your investment pot. Usually this is more, sometimes significantly more, than 1.4% per year.

For example let's say you buy an active fund that invests in UK stocks. You​ are buying the skills of a team of highly skilled stock-pickers and the goal is to outperform the FTSE 100. Your stock-pickers have a deluge of information at their fingertips in the form of company reports and accounts, analyst reports from investment banks about the prospects of each company and even access to speak to senior management at each company. And yet research shows that over the long-term 75% of UK stock market fund managers failed to beat their index. But they still expect to be paid!

SPIVA report Europe

Orbis Investment Management's Radical Fee Structure

We first came across Orbis when one of our viewers on YouTube pointed out that the only active fund he uses is Orbis because their fee is lower if they don't outperform their index. We were amazed when we looked at Orbis' website, branded as Orbis in the UK, to see that this is exactly what they do, and yet few people have heard of Orbis, and few other fund managers have adopted their "symmetric" fee model.

A symmetric fee means the fund manager loses when the fund loses and gains when the fund gains: this aligns their interests with those of the investor

Before we begin let's make sure you know what constitutes a low fee and a high fee. For a passive fund which simply tracks the performance of a stock market index the fee can be as low as 0.07% each year. For a hedge fund the annual fee can be as high as 2% per year whether they succeed or fail, and they may take up to 20% of the upside if they make a profit. The average all-in fee for an active fund is 1.4% according to a Lipper Research report from 2015. Orbis' fee structure is much more modest than hedge funds and more honest than most active funds that aim to beat an index.

The key idea to understand how Orbis fees work is the Reserve Fund. You're probably familiar with the idea if you've come across the story of Pharaoh's dream of seven fat cows and seven skinny cows in Genesis:

"​Let Pharaoh appoint commissioners over the land to take a fifth of the harvest of Egypt during the seven years of abundance. They should collect all the food of these good years that are coming and store up the grain under the authority of Pharaoh, to be kept in the cities for food. This food should be held in reserve for the country, to be used during the seven years of famine that will come upon Egypt, so that the country may not be ruined by the famine."

Similarly, when the fund beats the benchmark half of the outperformance is siphoned into the reserve fund. This is a fat cow year. When the fund underperforms money is fed back into the fund, to the tune of half the underperformance. This softens the blow for the investor and hurts the profits of the fund manager during thin cow years.

Orbis Reserve Fund Examples
Orbis Reserve Fund

Any fees paid to Orbis are taken from the reserve fund. The fee they receive is the lesser of 2.5% of the fund value or 1/3 of the reserve.

If Orbis have a streak of underperformance and the reserve runs out they won't take a performance fee until the fund reaches its previous level when the reserve ran out. This level is called the Reserve Recovery Mark and offers another fee cushion which benefits investors.

However this fee structure is not always beneficial. In the event that Orbis outperforms the benchmark by more than 2.75% their fee edges above the industry average of 1.4%. However you could argue that if Orbis deliver above industry norms then they should be compensated for that outperformance. And as they say only one in four fund managers amongst their peers achieved this level outperformance in the period from 2010-2015. Orbis are completely open and transparent about this on their website, as you can see in this infographic which they provide:

Orbis Fee Comparison

Finally let's take a look at how well Orbis has performed and the actual fee that they have charged as a result. Orbis is fairly new and so there isn't much in the way of historical performance data. However Orbis  has another performance-based fee structure that dates back to 1990. You can see that they have hit their management fee cap quite a few times, but also had to dip into their reserve three times (the Asian / Russian crisis in 1998, the dot com bubble bursting in 2000 and 2012).

Orbis Management Fee History

Orbis does have performance data on their website for 2016. Their performance warranted a high fee of 2.5% for their Global Equity Fund (which tracks the MSCI World Index) and 3.7% for their Global Balanced Fund (which is split 60% into the MSCI World Index and 40% into the JP Morgan Global Government Bond Index). The other thing that deserves praise is that they show the often hidden trading costs which they incurred buying and selling assets for the fund. This level of fee transparency is a rare and wonderful thing.

Orbis 2016 Fees

Although Orbis funds may end up costing you more than other active funds if they outperform they will almost certainly cost you less if they underperform. A symmetric fee structure should be the norm. Just like Bob Bowron, skilful fund managers should be paid for their craft.

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