A Long-Only Manager’s Radical, Logical Idea of Zero Management Fees
As some of you might know, at Marcellus we offer clients an unusual fee structure: we charge fees only if we deliver in excess of 8% and our fees are a fifth of the return generated in excess of 8%. Now, an American wealth manager has done some research which provides intellectual justification for our approach.
Westwood, a Dallas based wealth manager, has found that: “The problem for active management is not high fees, but rather that they charge investors during inevitable periods of underperformance…Under the traditional model, “You’re paying a fixed fee for an uncertain outcome,” said Westwood’s Philip DeSantis, head of product management, in an interview. “Beta drives a large portion of the total return for any long-only mandate, even though the active manager gets paid on the entire bucket,” he said…Investors paid more than $105 billion in fees to underperforming large cap managers in the last 10 years as of the end of 2018, according to Morningstar…Over the last five years, investors paid median fees that amounted to 45 percent of the return of market-neutral funds and 63 percent of returns in the multi-alternative fund category. Even in categories thought of as inefficient, such as SMID — a mix of small and mid-cap stocks — only a little more than 40 percent of institutional products outperformed their benchmarks over 10 years, the manager found.”
So what is the remedy for these sorts of illogical fee structures? “Westwood came up with a radical proposal: Charge zero percent for managing capital and 30 percent for outperformance — a 0-and-30 model.
For example, an investor with a $100 million portfolio that earned 5 percent annually over 20 years would save $9.2 million in fees under a 0-and-30 structure versus a flat 0.40 percent management fee.
But more importantly, paying only for alpha would help investors grapple with volatility. In bad years, investors do not pay any fees. Active managers need to give investors a better probability of winning, DeSantis said.”
So why is Westwood offering this fee construct? “DeSantis said the effort is designed to beat back the trend to passive, particularly in the most efficient asset classes like large cap stocks. In large caps, for instance, the best managers hold concentrated portfolios, and inevitably have periods of underperformance. If an active manager charges a low base fee combined with a performance fee, there’s little incentive for investors to opt for passive. That’s because the active strategy is only charging for the alpha it creates in the years that it is actually produced, DeSantis explained.”