On 7^th November 2017, we introduced Orbis OEIC Global Equity (Standard) to The Adviser Centre (see bulletin and fund factsheet).

The Standard Share Class of this fund is subject to an innovative fee structure and we thought it would be useful to provide some more detail, particularly as it is a topical subject at present.

In summary, the only way in which Orbis Investment Management Limited (Orbis) is paid for running the fund is through the performance fee.  There is no annual management fee and, subject to conditions (see later under “Other fees”), the ongoing charge figure (OCF) is zero.

Performance fees and Orbis

Performance fees are sometimes regarded with suspicion, perhaps because of the way they have been calculated in the past (the relevance of the hurdles used and whether, or not, high watermarks are applied), or, more subjectively, whether they incentivise a manager to make inappropriate investment decisions in the pursuit of a performance target.  Furthermore, some feel uncomfortable not knowing in advance what level of fees they will experience.

Clearly, performance fees that are applied to success in relative performance are more complex than those applied in the world of absolute performance, which goes some way to explaining why they remain a rarity.

Orbis has operated a performance fee structure on this fund since launch in January 2014 and hence, the process is well established.  In short, a performance fee is only applied when the fund has outperformed its index. This means that the outperformance enjoyed by the investor is diminished as a fee is levied.    On the other hand, when the fund underperforms, a repayment system reduces the impact of the underperformance.  The performance fee is paid into a reserve, from which Orbis is remunerated over time.

In practical terms, this means that in some years, Orbis takes no fee because of underperformance, but in other years, when outperformance is significant, the fee can be material.  Given the potential for lean years, it will come as no surprise that this performance fee approach is only possible because Orbis is well-capitalised.

Orbis OEIC Global Equity (Standard) performance fee structure

In simple terms, the performance fee is calculated as follows:

• 50% of any outperformance over the benchmark (MSCI World index) is paid out of the fund.
• When underperformance occurs, 50% of the underperformance is paid back to the fund.
• Payments and refunds are calculated and effected on each dealing day.

How the performance fee operates

• The fee is administered through a Reserve.
• Accruals are made to the Reserve by the fund when outperformance occurs.  This has the effect of reducing the NAV of the Standard Share Class.
• Refunds are paid from the Reserve to the fund when underperformance occurs.  This has the effect of adding to the NAV of the Standard Share Class.
• Refunds only occur when there is sufficient value in the Reserve.  When the Reserve NAV reaches zero, a Reserve Recovery Mark is set.  Thereafter, the Standard Share Class will not be charged for any outperformance until any subsequent underperformance is fully recovered.  This system is akin to a high watermark, as it ensures that past underperformance is carried forward.

In practice, this operates as a kind of “IOU” system, whereby no performance fee is taken during this time, although the daily calculations continue on.  Therefore, investors experience the full effect of any out/ underperformance, as no accruals or refunds are taken from, or added to, the fund.  During this period, any accruals awarded for outperformance are netted off against the effective IOU for historic underperformance.  The system only reverts to normal when the refund for historic underperformance has been recouped and the Reserve is back in credit.

How Orbis is paid

• Orbis’ only source of income from this fund is a draw from the Reserve.
• The draw is non-refundable and is subject to a limit, which is the lesser of: one third (annualised) of the Reserve NAV, or, 2.5% (annualised) of the NAV of the Standard Share Class.
• This draw is paid out of the Reserve on each dealing day, when the Reserve NAV is greater than zero.

Other fees

Orbis covers other fees that usually form part of a fund’s OCF.

• Orbis pays the fund’s ACD and the Registrar fees.
• In addition, certain operating expenses are paid by Orbis, up to a maximum level, equivalent to the larger of:
  • 0.1% per annum of the NAV of the fund, and;
  • £1,000,000 per annum.

Orbis does not cover the costs of buying and selling assets, interest and brokerage charges and relevant taxes.  These costs are borne by the fund.  (Such charges are not typically included in OCF calculations.)

As a function of this fee framework, the OCF of the fund has been 0.00%, on an historic basis.

Other points to highlight

As with any formalised system, there are situations when some investors may be advantaged or disadvantaged.

• In periods of underperformance, an investor may not always be able to receive a refund.  This is because when the value of the Reserve NAV falls to zero, no refunds will be paid.  (See information above on “Reserve Recovery Mark”).  There is no legal charge over unpaid refunds in the event that the fund is wound up, ceases to operate or fails to recoup sufficient fees through outperformance.)
• In addition, fees are not calculated on an individual shareholder basis.  The fees and the refunds are calculated on the entire Standard Share Class and allocated on a per share basis.  Some shareholders could benefit disproportionately if, for example, they invest after a period of strong performance which is then followed by a period of underperformance.  Such a situation would result in refunds into the Standard Share Class.  New shareholders would benefit from this, even though they did not contribute into the Reserve during the earlier period of outperformance.
• It is important to remember that the performance fee can be paid even when the NAV of the fund falls in absolute terms.  The payment of the performance fee relies upon relative performance, not upon absolute performance, which means that outperformance in a down market is still rewarded with a performance fee.
• Furthermore, if the fund delivers strong outperformance, shareholders need to remember that they may be charged a higher fee than would have been the case with a traditional fee structure.

Alignment and incentivisation

Orbis argues that this fee structure is in keeping with its distinctive, performance-driven culture.

With regard to performance fees, some people worry that a manager could be tempted to be overly short-term, or worse, take inappropriate investment decisions in the pursuit of performance targets.  Orbis has countered this by creating a performance fee system that does not have a periodic performance crystallisation point, but instead operates a daily and on-going accrual process.

The firm also encourages its analysts to take a long-term view and is tolerant of short-term underperformance by individual analysts, acknowledging that this is often outside their control.  The performances of members of the investment team are assessed annually, but critically, any significant out/underperformance is carried forward to ensure that performance is assessed over the long term.

Furthermore, exceptional performers are offered the opportunity to participate in the profits of the firm, aligning them with its success in adding value to its clients over the long term.  The firm’s founders, owners, management and employees and their family members co-invest in the Orbis funds alongside other shareholders and pay the same fees.  They argue this give them powerful incentives to behave as stewards of their clients’ capital.

As an aside, at The Adviser Centre, we do not cite a preference regarding co-investment by managers when we make our recommendations. We recognise that co-investment can foster alignment of interests and good stewardship.  However, we also acknowledge that co-investment can impinge upon a manager’s investment objectivity.  Therefore, we consider co-investment on a case-by-case basis, but do not apply a blanket rule.

Further information available

Orbis has included detailed information and illustrations in the prospectus and other marketing materials to help investors to understand the fee structure.  Please refer to these important documents for more information (www.orbis.co.uk).