broken asset class

Offer for new customers only

Issue 6 - 4 August 2020

This is a phrase one hears a lot here in the UK. Your broadband provider or your gym is offering a wonderful new deal, but as a loyal customer of five years you are not entitled to the benefit. I recently found out my Vodafone billing rate is about double what it would be if I had signed up today. I naively assumed that if prices fell, mine would fall too.

Asset managers are just as guilty. Too often I see managers offering lower fees to new investors than to those who have been with them since the early years.

Why is loyalty not rewarded? Maybe a special, lower fee share class for investors who have been invested for three or five years. In the case of closed-end funds, one could do this for investors who backed your first fund.

This is part of a broader discussion around fees, and management fees in particular, where assets under management (AUM) chasing is strongly incentivised by high management fees even if the asset class is unsuited to such large funds.

As a long-time, loyal investor, additional inflows may just be diluting the few best ideas that you have been paying so handsomely to access. One way I have seen this addressed is by a fixed absolute management fee. For example, the manager charges X dollars per annum for overheads and this is only reassessed every few years in a proper budgetary process. This way, the management fee per investor reduces as AUM grows, and the incentive for excessive AUM is much reduced. It is certainly better alignment than the current norm of additional AUM benefitting the manager, but possibly actually hurting the investor.

In private debt, the average fee fell from 1.76% in 2016 vintage funds to 1.5% in 2017 vintage funds, so there is already downward pressure1. As a manager, we’re obviously not hoping for downward pressure on fees, but we are hoping for improved alignment between managers and investors.

Some investors may ask - is a management fee even necessary? If the manager is already successful and wealthy, why not make their (hopefully handsome) incentives entirely contingent on success? The author and investor, Guy Spier, has done some research on zero management fee funds.2

Rather hypocritically, we are not aiming to be a low fee manager, and there is definitely value in being able to pay well and compete for the best investment talent. I’ve even seen investors insist on a slightly higher fee. As an investor, I’d rather have high fees and a high net return than the opposite. We’re simply making the case for examining fees from first principles and really asking what the economic incentives are for each party. If you can get a manager to compound your money at a higher rate (even if the total fees are higher) because they think carefully about every marginal dollar they accept, then you probably have excellent alignment.

While we have no plans to offer a zero-management fee class in our first fund series, you can be sure that our early investors will be getting the best deal when the next series launches.