Could 0% management and fair performance fee be better than indexing?

[inventiontime]

Greetings fellow mustachians,

Recently, I found a product that made me think there may be a better way to invest than indexing. I came across a product (when searching for index funds by sorting investments by lowest fees), that charged a 0% management fee and a 50% performance fee on its performance above the index (in this case MSCI world). If the fund unperformed, 50% of underperformance is refunded to the fund. If there is not enough money in the designated reserve store, then a reserve marker is used to only charge a fee once any unpaid refunds are earned back. I've listed the relevant quote from the Key Investor Information Document and a link to the KIID below.

It seems to me that this structure is a good alternate option to indexing, as your interests are aligned with the fund managers. If they don't do better for you than you would have done in the index, they can't eat. A risk with this type of fund that springs to mind is that a manager could setup such a fund and go for extremely risky investments hoping to outperform, lose everyone's money and then have a reserve marker so low that he closes down the fund and opens another one. It seems to me that buying a fund that has been around for 5 years+ would help to limit this risk. What are your thoughts on this type of fund? Do you think it's worth trying?

"The performance fee is 50% of the outperformance of the Fund over its Benchmark. The fee is paid out of the Standard Share Class and invested into a Reserve from which the manager draws periodically when there is sufficient value in the Reserve. The performance fee is refundable to the Fund at the same rate (50%) in the event of underperformance relative to its Benchmark in future periods when there is value in the Reserve. The performance fee is not charged for periods when the Fund is below its Reserve Recovery Mark."

https://www.orbis.com/documents/Orbis%20Global%20Equity%20Standard.pdf

[Metalcat]

The presupposition here is that fund managers generally under perform because they're not under enough pressure.

Do you think that's accurate? That fund managers would perform better at their jobs if they just had more pressure on them?

If you think that's accurate, then I could see this model producing better returns, but I've known a few people in this world and the pressure they are under is pretty extreme already. It doesn't sound like they are failing to produce better returns because of lack of motivation.

[uniwelder]

I’m not interpreting this as a method to outperform (because they’re not likely to succeed), but as a method to smooth returns. You’re not getting the benefit of all the gain, while not being hit with all the loss. It sounds like surplus returns are put into a rainy day fund, rather than the manager’s pocket.

[Metalcat]

I’m not interpreting this as a method to outperform (because they’re not likely to succeed), but as a method to smooth returns. You’re not getting the benefit of all the gain, while not being hit with all the loss. It sounds like surplus returns are put into a rainy day fund, rather than the manager’s pocket.

Okay, then I really don't get the benefit.

The main benefit of indexing is the low cost. What is the benefit of active management here if it's not to expect a substantially higher return to offset the cost?

If the benefit isn't better performance, then how is it a superior alternative to index funds??

I could see how it might be a superior alternative to traditional managed funds, but what advantage are you saying this has over index funds??

Basically, what benefit am I paying for?

[uniwelder]

I’m not interpreting this as a method to outperform (because they’re not likely to succeed), but as a method to smooth returns. You’re not getting the benefit of all the gain, while not being hit with all the loss. It sounds like surplus returns are put into a rainy day fund, rather than the manager’s pocket.

Okay, then I really don't get the benefit.

The main benefit of indexing is the low cost. What is the benefit of active management here if it's not to expect a substantially higher return to offset the cost?

If the benefit isn't better performance, then how is it a superior alternative to index funds??

I could see how it might be a superior alternative to traditional managed funds, but what advantage are you saying this has over index funds??

Basically, what benefit am I paying for?

I don’t see any long term benefit. The brief history of the fund returns isn’t attractive, and managed funds generally don’t outperform. I wouldn’t put my money there.

My post was just explaining how I interpreted the fund to act.

[habanero]

This particular fund has underperformed its benchmark (MSCI World hedged to GBP) quite significantly over pretty much any period you look at as far as I can see so the non-benefit of it should be quite clear.

[inventiontime]

Thanks for your advice, that makes perfect sense. I'm sticking to index funds!

[habanero]

Thanks for your advice, that makes perfect sense. I'm sticking to index funds!

Prob the wise choise in the long run. Very few active managers outperform the index in the long run. This does not mean that such managers don't exsit, but its pretty much impossible to know up-front which one actually will. Also, there are so many trying that some will outperform fairly consitantly over several years even by sheer luck. A lot of highly paid smart folks spend 60+ hours a week trying to achieve this, most don't, at least not after fees which can be substantial.

The fund you linked to appears to try and achieve a few things: They do stock picking - probably still staying well diversified, they also actively manage their FX exposure so they also try to outperform a passive FX hedging strategy so they need to, over time, outperform on both fronts.

That said, the recent case for passive indexing might be a bit rosier than reality - the last 10+ years the winning strategy has pretty much been to buy everything and close your eyes, the performance of long-short equity funds has been pretty bad relative to index as almost everything has ripped. If - and that's a bif if - we transiition to say a decade of stocks not really going anywhere the outcome might be quite different. But regardless you can't know in advance.