Orbis’s Brocklebank: Fee debate is long overdue

The recent move by Fidelity International to introduce a performance-based fee is a step in the right direction for the UK fund management industry. The industry has failed to demonstrate value for money and, unfortunately, hasn’t done a good job for its clients over time.

The Financial Conduct Authority’s final report in June, shone a harsh light on fees charged by the industry. It has placed some pressure on the industry to address the issue of value for money, potentially by looking beyond the standard ad valorem fee model which has served investors poorly for far too long.

Few topics in investment management are as contentious as fees and expenses. When the FCA announced its findings, some observers—mostly fund managers—were quick to complain that the regulator came down too hard whilst others claimed that the report didn’t go far enough.

The fee debate is extremely long overdue and we for one are very welcoming of it. For too long the passive investing camp’s knee-jerk mantra of “lower is better” has dominated the discussion about fees and charges. While there are many good arguments in favour of a low-cost passive approach, it is naïve to suggest that it is the only way to manage money. Indeed, many investors have a mix of both passive and active strategies in their portfolios—and there is no reason the two approaches can’t co-exist and produce successful outcomes for clients.

The real key—whether you choose a passive strategy, an active one, or a combination of the two—is to look for well-designed incentive structures that align the interests of the manager and the client. At present, the overwhelming majority of fee structures are simply a fixed percentage of assets under management. Under this model, the amount of revenue that an asset management firm generates is almost completely detached from the investment performance that their clients experience.

The FCA said it best in its Interim Report: ‘The prevailing fee model incentivises firms to grow assets under management, which is not necessarily aligned with investors’ best interests.’ Vanguard founder Jack Bogle once put it in more colourful language, referring to flat fees as the ‘croupier’s take’.

Our profession attracts many competitive and hardworking people who genuinely want to perform well and to see their clients succeed. But those well-intentioned individual efforts are no match for the collective commercial interests that come with flat fees. The inconvenient truth is that it is almost always easier for an investment firm to increase assets under management by deploying additional resources in sales and marketing rather than by seeking superior investment performance.

An obvious solution, and one which Fidelity is now seeking to do, is to create a better link between the fees charged and the performance delivered.

There are a number of obstacles to making performance-based fees work well in practice. Performance-based fee structures have developed a lousy reputation over the years, thanks in part to the “two and twenty” or “heads we win, tails you lose” structures made popular by the hedge fund world. A further obstacle is operational—performance-based fees are more complicated for managers to implement and for investment platforms to accommodate. And finally communication has been an issue with performance-linked fees sometime being much harder for clients to understand therefore allowing room for misunderstanding.

As a profession, we cannot afford to allow past mistakes to stand in the way of a better solution for our clients. The operational issues are all manageable, there is absolutely no reason why the calculation of a performance-based fee cannot be just as transparent as that of a flat fee, and there is no reason fee structures can’t be explained clearly.

The FCA deserves credit for leaving room for well-designed performance fee structures, and Fidelity should be applauded for taking up the challenge and trying a new approach.

At the end of the day, we think that it can only be good news for investors if more industry participants step forward to raise the quality of the debate and to try and become part of the solution. For advisers and their clients, we think that will make for better long-term choices. Ultimately, and given how powerful incentives are, wouldn’t you rather invest with a firm that is paid to do well rather than one that is paid to make their firm bigger?

Dan Brocklebank is head of Orbis Investments UK