Allan Gray’s offshore partner Orbis is introducing a new fee structure for African investors.
Summary of the key changes
- The net impact of the changes is a reduction in fees paid by investors in the majority of circumstances.
- Like traditional performance fees, the fee structure will have a fee at benchmark (i.e. a base fee) and a performance fee component. However, unlike traditional performance fees, the performance fee component will be refundable. This simply allows Orbis to refund previously paid performance fees, thus lowering fees when investors are experiencing underperformance.
Frequently asked questions
Here are some answers to frequently asked questions about the proposed fee structure.
- Allan Gray and Orbis are known for keeping it simple, so why is the fee structure so complicated?
The notion of a refundable performance fee and fee reserve is new to South African investors and may seem complicated, but the principle is simple: It ensures that performance fees are only levied if the fund generates sustained outperformance and Orbis can refund fees during periods of underperformance.
- Is the new fee better for investors?
Yes, with a performance fee refund available, the new fee is lower than the current fee, except where there is meaningful outperformance, when the fund outperforms its benchmark by 6% per year or more before fees. Looking at this historically, using the last three years of performance data for the Orbis Global Equity Fund (as at 30 April 2019), the new fee would have been approximately 25% less than the current fee. However, the recent performance has been weak. Had the fund outperformed by 3% per year, the reduction would still have been 15%.
This overall reduction in the fee is achieved by lowering the fee for benchmark performance in the Orbis funds from 1.5% per year to 1.1% per year, but also by increasing the sharing in both out- and underperformance (i.e. the sharing rate) as outlined below. (Note that base fees quoted include administration fees).
- The base fee is lower but the performance fee sharing rate has been increased. What is a sharing rate and how does this work?
A sharing rate is the percentage at which a manager shares in the out- or underperformance of the fund relative to the benchmark.
The Orbis performance fee component is calculated by applying the sharing rate to the difference between the fund return, after the base fee has been deducted, and the benchmark return. The sharing rate is 25% of this difference, which applies to both out- and underperformance. The annualised sharing rate has been increased, however along with a reduced base fee, a shortened measurement period and a refundable mechanism – the net result is a fee which is more reactive (importantly on both the upside and the downside), lower under most circumstances and more aligned to the performance clients experience overall.
- How does the refund mechanism work?
Under other performance fee structures, when a performance fee is charged, it accrues to the manager immediately. Under Orbis’ refundable structure this is not the case. Instead, it flows into a fee reserve which is invested in the fund. This fee reserve is used to refund investors during times of underperformance, at the same 25% sharing rate.
As a simplified example, if the fund returns an annualised rate of 7.2% before fees and the benchmark returns 3%, the gross outperformance is 4.2%. After deducting the base fee of 1.1% per year, the outperformance is only 3.1%. A percentage sharing rate of 25% is then applied to this 3.1%. This results in the investor paying a performance fee component of 0.775% per year, which is also added to the fee reserve. The investor therefore pays a total fee of 1.875%.
If the fund underperforms by an annualised rate of 2% before any fees are charged, then after deducting the base fee the underperformance is 3.1%. A 25% sharing rate is again applied to -3.1%, which equates to a negative 0.775% per year. In scenarios where there are funds in the reserve, this negative performance fee of 0.775% per year is then refunded to the investor from the fee reserve, which results in the total fee reducing to 0.325% (1.1% - 0.775%) per year. If there is no balance in the fee reserve, a running total of any underperformance is recorded and needs to be made back prior to any additional performance fees being levied.
- What is the minimum fee that Orbis will charge?
The performance fee paid into or out of the reserve is unlimited on the up- and downside. Performance fees charged are paid into a fee reserve and will be refunded to investors if there is subsequent underperformance. So there can certainly be times when investors will get paid a fee (i.e. the fee is effectively negative). If there are no funds in the fee reserve the base fee will be charged, but the underperformance needs to be recovered before performance fees can be charged again. The maximum performance fee that Orbis can earn from the fee reserve is limited to the lower of 2.5% of the net asset value of the fund per year, or one-third of the fee reserve per year.
- The measurement period has been substantially reduced. How can a long-term manager have such a short measurement period? Does this mean that underperformance is deleted after one week?
The shorter measurement period makes the fee more reactive, which means that investors will pay fees for performance that they experience at that time. However, it is important to note that the shorter measurement period does not mean that Orbis will collect the fees more quickly. The performance fees are collected in a fee reserve. In times of underperformance investors will be refunded from this fee reserve.
- Will Orbis’ recent underperformance be accounted for in the new Orbis fees?
Yes, it will. Any fee reduction that would have been experienced on the current fee as a result of the recent underperformance will be accounted for in the new fees in addition to the new benefits.
We believe this represents a significant improvement in the fee structure that, with a performance fee refund available, will see lower fees in all scenarios, except where there is meaningful outperformance – when the fund outperforms its benchmark by 6% per year or more before fees.
For a detailed explanation of the new fee, and a comparison with the current fee, please refer to Orbis: A meaningfully improved fee structure