Performance fees pay off for Milford
Clients welcome a focus on performance fees rather than base fees, says Milford Funds, even when that means a fund manager’s fee income soars in good times.
Tuesday, July 23rd 2013, 7:10AM 45 Comments
by Susan Edmunds
Milford Funds, a unit of Milford Asset Management, has reported a big jump in profit as a result of strong investment returns on increasing funds under management.
For the year ended March 31, Milford Funds had profit of $7.36 million, up from just $1.05 million a year early. Fee income increased 257% to just over $19 million.
Expenses increased to $8.82 million from $3.87 million a year earlier.
Managing director Anthony Quirk said the low base charge and a higher performance fee was something that was a good philosophical fit for the firm.
“We didn’t want to be a fund manager that just clipped the ticket even if the fund didn’t do well for clients.”
He said unit trusts of late last century generally did much better for the managers than they did for the clients, because of the fees charged.
Quirk said Milford wanted to offer a capped base fee that was low relative to standard management fees, but then charge a fee for good performance. Its base fee is 1.05%. “So if the client did well, we would do well. Clients responded well. Talking face-to-face, especially with sophisticated investors, they understood the problems with paying relatively high fees but not getting a good return. This way, they still get most of the upside but know if we don’t do well, we don’t earn so much.”
Milford was the fastest growing fund manager in New Zealand in the March quarter and Quirk said he expected the June data to be strong, too. There had been no pushback from investors in response to the increase in performance fees being collected by Milford, he said.
Its active growth fund was the biggest contributor to the increase in performance fee. It returned 25.3% after fees before tax in the year to March 31. Milford earns 15% of any return that it delivers for investors above the 10% target, after fees. Quirk said: “We effectively have to get 11% for the client before we share in any performance above that level. Some overseas hedge funds charge 2% plus 20%. We didn’t think that was fair.”
He said PIE funds offered an efficient structure that could be very beneficial for clients.
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You are not comparing apples with apples with your comment above as the Active Growth Fund has bonds, cash and equities.
I disagree with your point about same risk and better return from NZX as I think you could find the Milford fund probably has a lower std dev.
You would have to calculate the risk adjusted returns to make a meaningful comparison.
I don’t think any adviser should be suggesting to any prospective client that the dramatic outperformance of Milford’s early years is going to be repeated on a dramatically increased asset base so wonder about the relevance of your last comment. The biggest problem I have with actively managed funds is when they try to extract a high performance fee by misrepresenting their benchmark. There are lots of offenders in NZ and some are worse than others and some funds are worse than other funds. I can think of an income fund with a particularly odious performance benchmark.
Regards
Brent Sheather
I did provide facts - in the form of the actual performance of the NZX and Milford since the inception of the Active Growth Fund in October 2007, to 30th June 2013. Hence my reference to 5.5 years - though actually it's more like 5.75 years. Over this period the NZX returned 0.6% p.a.
Re performance fees, the reality is that if Milford were benchmarked against the NZX instead of 10% absolute, they would have made far higher performance fees than they have, especially in the early years, so you can hardly accuse them of choosing an unfair hurdle!
Past performance is not indicative of the future of course, and yes, Milford will have to work hard to replicate their previous numbers with a $700m+ fund, but I'd rather not invest in NZX trackers as I don't want 40% of my exposure to about 10 boring and largely ex-growth companies.
There is no denying Milford’s good performance and this is why we support their funds, in addition to the good work Brian does keeping market participants honest. And yes Milford could have made more money if they were benchmarked against the proper index. The point is however that they aren’t benchmarked against a proper index and there are numerous research papers supporting that view not to mention common sense. If you want to find an unfair hurdle then I suggest you look at various income funds offered locally.
On your last comment you don’t have to limit yourself to “10 boring ex growth companies” with ETF’s. There are lots of other alternatives, those 10 stocks you are talking about are probably priced to reflect their growth prospects and last but not least they are probably all in the Milford fund to some extent or another anyway.
Regards
Brent
b) How much improvement in market efficiency is provided by your policy as implemented by you?
c) What's the direct benefit to your client of b?
I'm happy to pay personally and let's be honest 15-50 basis points for active isn't excessive is it?
I criticise active managers when they make ridiculous claims, charge too much and extort excessive fees thru unfair performance benchmarks.
To answer kimble if my average active manager costs 40 basis points and alpha is zero then the number is 40bpts.
b.none but if everyone took that attitude markets would cease to function.
c.a good nights sleep maybe.
Rgds B
So your decision costs your client something, and gives them nothing in return? Do your clients KNOW that they are paying extra for nothing? Do they really UNDERSTAND the costs and benefits of your decision?
Your response is nonsensical. You claim that your clients are paying their "fair share" of the costs of keeping the market efficient, but then say that the amount they are paying doesn't improve market efficiency at all.
If what your clients are paying doesn't improve market efficiency at all, then their fair share of the costs is nothing.
Put another way, without your explicit decision to the contrary, markets would stay efficient AND your client would earn more money. You are turning a WIN-WIN situation into WIN-LOSE.
Put yet another way, all those other investors who are creating efficiency in the market through their (according to you) mistaken pursuit of alpha, are effectively donating value to your clients. You are taking that value, and then giving all of it, plus a massive amount more, to some lucky active managers.
And yet you say you sleep well at night.
I thought the whole point of active management, according to active managers anyway, was to pick stocks that will outperform. That's why active managers like Templeton stay more or less fully invested.
What this discussion does maybe highlight however is the woeful state of CPD in NZ.
By the way Vanguard research shows that active managers don't inevitably outperform in falling markets...some do but many don't and performance doesn't persist.
A few things that you should consider :
1. The average US institution indexes half its equity exposure. We do the same, for the same reasons. One imagines that given the assets involved in the US “they really understand the costs and benefits of their decision”.
2. The average total fee paid by our clients in respect of an investment proposal including our monitoring fee but excluding initial fees is about 50 basis points. That doesn’t seem like we are “giving all of it, plus a massive amount more, to some lucky active managers”.
3. We manage $650m with 2.5 advisers, one of whom is responsible for research and are I’m so busy I’m not taking new clients. That sounds like the market sees our investment proposal as a “Win-Win situation” not a “Win-Lose” situation. If you are an AFA I would be interested to see comparable figures for your firm.
Regards
Brent
1. When you simply appeal to authority (again) without saying one thing about WHY that authority has made the decisions they have or how their situation is similar to your clients, then you leave readers with no option but to assume that you either don't know their reasoning or that you don't care and are looking for post-hoc justification.
2. 40 bps for active, 20 bps for passive, zero gain from active, half the portfolio is active, 650m invested... hmmm. Back of the envelope reckoning puts that at $650k missing from investors portfolios on an annual basis ($650k less with which to fulfill their dreams and aspirations). How much is added to their portfolio due to their contribution to market efficiency? Nothing, as you admit. That's an expensive nights sleep.
3. So when I ask you whether your clients KNOW that they are paying money for nothing, you respond to tell us how much these potentially unaware investors have entrusted you with? Do your clients KNOW they are paying higher fees for nothing in return?
You constantly disparage other advisers for paying for active management, and claim that they do it for corrupt reasons. But you invest with active managers too. Oh, but you don't do it for the same reasons as those other stupid, corrupt guys, right? You do it to maintain the efficiency of the market.
So when you admit that market efficiency isn't improved one bit by your actions, you just leave people wondering, why are you really doing it? They could be forgiven for thinking your reasons might actually be the same as those people you disparage.
Your argument that 'if everyone invested 100% passive, markets would stop working' is laughably ridiculous. Consider how unlikely it is that everyone would change to investing in passive and how much your token effort (with clients money) would change things if they did.
Given that there is zero chance of everyone going passive AND that your donation to active managers has zero times zero chance of affecting anything AND that you don't think active management adds value, your stated reason for investing in active managers doesn't stack up.
I have little problem with having half your portfolio in active managers or your entire portfolio in passive. But your stated reason for doing so doesn't make any sense.
Your argument that because the market supports your model, it must be right, is an obvious fallacy given the massive failures of well supported business models recently. I get them impression that you at least have your clients interests at heart so I am sure you are not a RAM in waiting, but the incessant flogging of everything that isn't your way is tiresome, generally just wrong and not really helpful.
Market timing in not that hard - if the market is overvalued, reduce equity exposure. If equity markets are cheap, increase equity exposure. If bond markets are expensive (i.e. zero or negative real returns), sell bonds. They key is the timeframe you look at. If you're trying to time markets daily or monthly, forget it. Over a 3 to 5 year period, it ain't rocket surgery.
No, I'm not an AFA. Just someone who's been in the fund management industry for 27 years. If your 'education' has provided you with such a high degree of confidence in what you think you know, I really think you should be concerned.
1. The rationale is that it represents best practice and by the way it’s quite novel being criticised for supporting active management for a change.
2. My guess is that the average management fees implicit in our plans are between one half and one sixth of that of competitors, so not really an expensive night’s sleep.
3. Clients are paying for market exposure they are not getting nothing and the fees they do pay are a lot cheaper than most other options. I disparage other advisers who make claims about active and passive management that aren’t true.
Stan – I have always said that you cannot expect most active managers to outperform. I have never said no one should invest in active management. I have been investing in active managers since about 1988. I’m interested in facts and when I see people saying things which aren’t true I’m motivated to set things straight. My experience that the supporters of active managers are more inclined to abstract reality than most other people.
Anon – if you are a successful market timer good for you. You are one of the few who get it right. My “education” is just repeating what most academics say and I have more confidence in academics than people “who have been in fund management for 27 years” but won’t reveal their real names.
Regards
Brent
2. How much money needs to be spent on nothing before it becomes a waste?
3. I have been talking about the fee differential, not the total fee. There is a reasonable fee to pay for market exposure, and that's ETF rates. Your clients pay a premium for active management. The only reason you have given for them doing this, by your own admission, doesn't provide them with any value.
Your claim that your clients invest with active managers to 'keep the market efficient' is logically untrue. It doesn't, so they aren't.
So why do you really invest with active managers?
You seem to be twisting yourself into contortions to avoid saying that you invest in active managers to gain excess return.
Just admit it: you think that you can pick the active managers who will add value.
1. I tend to follow the big decisions of fund managers like asset allocation, duration, quality of bond portfolios, active/passive split etc overlaid by a consideration of fees and income.
2. Without giving too much away the active funds I use frequently give my clients management for free. I will leave you to think about that one.
3. My clients don’t pay a premium for active management. For example, AFI 15 basis points from memory versus SmartMOZZY … much higher. I have been using active managers for long enough to know that I can’t pick active managers who will add value.
But enough about me. Why don’t you tell everyone how you approach this issue, what fees your clients pay, how you allocate funds between active and passive etc.
Regards
Brent
I think that you will find that a fresh approach has arrived, with a major focus on fees and calling to account fund managers.
I'm also pretty motivated to keeping things straight, don't think for a second there aren't plenty of low fee, actively managed funds outperforming indicies. And don't get complacent or hubristic in your approach when dealing with clients to think that laws and approaches haven't changed.
2. So now you are saying that active management ISN'T costing you more? What happened to 40bps?
3. AFI is invested in large cap stocks. SmartMOZY is invested in mid-caps. A fairer comparison would be the SPDR 200, or the Vanguard ETF.
If I was the one making assertions, then I would have to back them up. But lets say that I also had a 50/50 active/passive split.
Lets also say that I was questioned on why I used active funds when I was known for constantly claiming that other people who used active funds did so for the wrong reasons.
And finally, lets say I then told everyone that I only invested in active funds because peer group comparison was an important part of fund selection, and I wanted to ensure there were enough active funds against which to compare my preferred passive funds. Some European pension managers used active funds, the extra cost my clients were paying was just their fair share, they could sleep better at night because of it, and besides that they weren't paying more for it anyway so there.
1. I think the reason US fund managers have half their portfolio in active is the same reason I do….. they need to ensure the markets stay efficient.
2. I’m not going to tell you and everyone else all my secrets! Maybe do some CPD and get enlightened. LOL.
3. Agree but AFI has lower fees than STW and frequently VAS.
On your last paragraph I completely agree with you.
Regards
Brent
prove that. And they cost plenty !
Milford have done well, but look when they started, and as FUM grows, watch returns decline.
Last years best fund, this years worst, or mediocre..........
Plus the Milford fund you are discussing is pretty much all NZ - if Wellington had had a tad bigger shake then how would an overweighted portfolio to NZ look this week?
Milford yesterday - great - but for tomorrow ???
2. Your secret seems to be claiming that active management costs 40 bps (as you did in an earlier post) and then claiming that it doesn't cost anything (as you did in a later post). One doesn't need to gain enlightenment to point out when someone is contradicting themselves.
3. If those examples still confirmed your story, then we have to wonder why you chose one of the most expensive ETFs out there for your comparison. You can make anything appear cheap by comparing it to something completely different that is way more expensive. (What do you mean this car is priced too high, have you seen the prices of houses lately?)
4. Then we can assume you would also agree with:
a) investing in active funds to keep the fund manager section in the phone book filled.
b) investing in active funds to make your passive ones jealous.
c) investing in active funds because, you know, like, maybe in a future life you might come back as an active fund, man.
d) investing in active funds because they are really just passive funds that follow a private index replicating the fund managers opinion.
e) some of your clients money is getting a little too emotionally attached to some of their other money, and you want to put it into active funds to "give it some space". They're on a break.
Graeme, perhaps you haven't been paying attention. The debate hasn't been active vs passive. The bulk of the debate has been about one person claiming to invest with active managers for patently ridiculous reasons and failing to defend doing so in the face of reasonable cross-examination. The rest has been dealing with the specifics of a particular active manager.
Perhaps you can point to the posts in fervent support of active management? Or are you just creating a strawman?
1. I didn't say all active fund managers go to cash in market corrections, I only mentioned Milford.
2. Most active fund managers don't have a mandate to cash up and see it as their job to stay fully invested, even if this means they lose money in a downturn. Milford's mandate allows them to move to cash/bonds if they think it's appropriate (which is a good reason why they don't use the NZX as a benchmark).
3. Fund managers have many more tools to protect portfolios than simply switching to cash (e.g. using options). Milford uses some of these strategies to protect portfolios in down markets without having to sell shares.
4. City of London has underperformed its benchmark over the last 3 years. Maybe they're cutting fees to try and win business because they can't sell the trust on performance? Just because it's cheap, it doesn't mean it's good.
I have owned this stock for at least fifteen years and note that it is on a premium. That suggests it is good! Regards Brent
Still, if the average trust has outperformed the UK index by that much, it's a BIG tick for active management, isn't it??
I see what you mean about there being money in things like smokes, as the City of London's biggest holding is British American Tobacco, with grog company Diageo also featuring prominently.
Regards.
George
On the active side: many (not all) quality active managers now announce their capacity on day 1, and stop accepting new business around that number.... retaining their investment dynamics in favour of their investors and not their shareholders. In my experience, those active managers that tend to prosper tend to have a "superstar" individual with unique talents, as opposed to the homogenous investment processes & philosophies marketed by large asset gathering entities.
Intermediaries are able to source this talent, albeit that any reliance on mainstream research will most likely mean that exposure is missed through "rating delays".
Bottom line: active management is alive & well, with some (certianly not all) investment talents continuing to deliver consistent robust returns in most market environments.
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