One of the questions we are always asked at our initial meeting with potential clients is “How much do you charge?” It’s a great question to ask because it has some of the greatest impact on your returns. Nintai currently has two ways we charge our clients. For those invested in our fund we use a model similar to Warren Buffett (Trades, Portfolio)’s original partnership. We use a hurdle rate of 5.0%. Anything beyond that is split 75% to limited partners (investors) and 25% to Nintai management. Any return below 5% Nintai makes no money. We are responsible for losses up to 25%. Nintai does not charge an advisory fee and has no lock up period. Individuals who exit before two years pay a penalty calculated in total assets. For our advisory services we charge 0.75% of assets under advisement. We keep this much simpler because we have no control – and little costs – associated with transactions, administration or distribution of investments.
We bring this up because we are interested in how managers see their investors through the lens of management fees. Wall Street seems to find an unending way to make sure fees and gains enrich themselves as much as – if not more than – their investors. A great report that analyzes fees is the Morningstar Fee Study. Published each year, the report goes into considerable detail about management fees in active and passive funds.
In its latest report[1] Morningstar reported that asset weighted expense ratios have dropped from 0.76% in 2010 to 0.64% in 2014. During that same period 63% of all fund classes and ETFs reduced their expense ratio while 21% increased their fees. The difference between active and passive funds is stark – active funds sport an average fee of 0.79% versus the passive rate of 0.20%.
Firms that have the lowest fees such as index funds continue to take market share going from 13% of total assets under management in 2004 to 28% in 2014. Investors are becoming increasingly savvy in choosing funds based on management fees. In 2004 20% of investors held funds with an expense ratio of 0.50% or less. By 2014 that had increased to 41%. It isn’t just management fees that investors are beginning to reject. By share class we have seen load funds decrease from 43% of all investments in 2000 to roughly 20% in 2014.
Management fees dropped in nearly all categories from 2009 to 2014. U.S. and International Equities saw the largest drop going from 0.74% to 0.58% and 0.94% to 0.77% respectively. The only category that increased in costs was Alternative Investments going from 1.24% in 2009 to 1.31% in 2014. This represented roughly 1.5% of total assets under management in 2014.
Passive shares continue to make serious inroads against the traditional share of actively managed funds. In every category – again with the exception of Alternative Investments – passive investing saw impressive gains. The largest gainers were U.S. and Sector Equity funds. Passive U.S. Equity funds increased from 26% in 2009 to 37% of total assets in 2014. Passive Sector Equity increased from 34% in 2009 to 46% in 2014.
First impressions can deceive
Looking at all of these numbers you’d be convinced it was a resounding win for investors as a class. Unfortunately you’d be only half right. If we invert the lens we see Wall Street has made out just fine with these changes.
From 2004 to 2014 estimated industry fees increased from $50 billion (with a “b”) to nearly $88 billion. Individuals in the investment management business will tell you this is due to two reasons – increased assets coming into the market and the market gains made from 2004 to 2014. And this is true. But as usual they tell you only half the story. During the 10-year period assets under management increased by 143% while management fees decreased by 27%. Consequently fee revenue increased by 78% – meaning investment managers and their employers made off with the vast majority of the gains.
The dichotomy of Wall Street trumpeting the reduction in fees and who received the share of savings is profound. Much like the advertisements that trumpet how great a company’s funds are doing, these claims disclose some – but not all – of the data.
So what’s all the fuss?
I bring all this up because costs matter a great deal to all parties such as Nintai, our investors and readers like you. Fees can make or break your long-term performance. As money managers we’ve given deep thought to aligning our interests with our investors. In our minds this begins and ends with how management fees are structured and calculated. As an investor you should demand that your management team aligns itself with your returns.
We recently participated in a round table and the subject of Mario Gabelli (Trades, Portfolio), founder of GAMCO was raised. Gabelli is famous for his shock of white hair and his equally shocking compensation[2]. Over the latest available five-year period ending 2013, Mr. Gabelli took home $294 million or roughly 20% of GAMCO’s total revenue. It’s a pretty good gig if you can get it. We think this kind of pay structure is obscene and disassociates Gabelli’s interest completely from investors in his funds as well as GAMCO.
At that same roundtable we discussed how and why Nintai structured its compensation. First – and above all – we have a fiduciary responsibility to our investors. This means our actions are guided by their needs and desires in the context of our investment model. Second, our returns are aligned completely with our investors. When they make money, we make money. When we lose money, they lose less money. Last, we see our investing operations as a passion that provides adequate compensation for our team. We aren’t in it to provide Harvard with a new building. Nothing would please us more if a building WERE raised – through a donation - from one of our investors. That means we’ve done our job.
Conclusions
We love the fact management fees are coming down. We think this is a great trend for the retail investor. But we believe we’ve fixed only half the problem. In the last five years the mutual fund/ETF managers have extracted roughly $400 billion (one-third of $1 trillion) out of the investment universe. How fees are structured – not just the percentages – are vital to finding investment managers who are truly financial stewards of your hard earned capital. You must get a clear and unequivocal assurance that people overseeing your money have a fiduciary responsibility to you as their investor. You should settle for nothing less. And I know Nintai won’t, either.
As always we look forward to your thoughts and comments.
[1] “2015 Fee Study: Investors Are Driving Expense Ratios Down”, Michael Rawson and Ben Johnson, Morningstar Research, April, 2015. The full report can be read here.
[2] For a great overview of this see “The Value Fund Manager With The $73 Million Paycheck”, Christopher Condon, Bloomberg Business, March 7th, 2014
