It’s All About Context

We frequently find ourselves engaged in conversation about fee structure in managed futures. Traditionally, managers will charge a 2% management fee, and a 20% incentive fee for returns over their prior high water mark with the investor. For investors who are used to seeing fees that look a little like 1.75% total for a year from an ETF or mutual fund, this seems obscene.

Our response is uniform – you get what you pay for. For many of our investors, managed futures performance (especially since it’s calculated including those “exorbitant” fees) is worth the fee structure. When managed futures investments do their job – as they did during the ’08 crisis – the outperformance is more valuable than the fees being paid back to the manager.

Once this conversation takes place with a world-weary investor, the fees usually become a non-issue in the decision making process, but that has never slowed down admonishments about the fee structure from the traditional investing space. For many advisers, in particular, there can be a fixation on how much an investment “costs,” without contextualization of the investment’s performance and role in a portfolio.

So when we see someone in the traditional space bemoaning this mindset, we breathe a sigh of relief, knowing that there are people out there who get it. Most recently, author of the financial planning industry blog Nerd’s Eye View Michael Kitces hit the nail on the head:

[…] if 2,700 basis points of outperformance is weak performance because it wasn’t an absolute positive return, but 10 basis points of expense ratio is so important to save, then maybe we need to look more carefully at outperformance and consider what we are comparing it to.

Of course, this is not to say that concerns about managing cost don’t matter. They absolutely do. It’s just astonishing the lengths that planners will go through to save a few basis points of cost, yet how little we value 100 basis points of outperformance, much less 1,000 or 2,700 basis points of excess return. It appears to me to be quite a double-standard!

Exactly. Cost and outperformance cannot be looked at in a vacuum – you have to juxtapose these factors with things like the investing climate, past performance, methodology, and portfolio needs. Otherwise, you miss the forest for the trees… or opportunity for a penny saved today. Just remember as you peruse the programs listed in our database – those listed returns INCLUDE all fees.

2 comments

  1. No offense, but I would say that the person missing the forest for the trees is you — hoary cliches like ‘you get what you pay for’ reek of the kind of noblesse oblige that has made passive/ETF enthusiasts out of scores of investors. You’re seeing many investors reject active management–probably in too wholesale a way, mind you–because they’ve tired completely of that rationalization, which has ill-served them time and time again.

    I also fault your logic, which supposes that a manager can charge an arm and a leg (which is unquestionably what you’re talking about when it’s 2 and 20) provided that he/she delivers net of those fees. First of all, as you well know, many managers/funds beat the benchmarks not through skill, but luck or excessive risk-taking. In situations like these, if I followed your reasoning, it would be cool if they charged a lot because, after all, they brought home the bacon, net of expenses. Really, though, is that ok, given what we know about mean reversion? Second, investors chase outperformance like catnip, even when said outperformance is really just a fluke or stylistic headfake. So, what we end up with is investors getting soaked with fees in a fund that, by the time they arrive (justification partly being ‘hey, this guy is awesome–killed his benchmark even after the costs!’) is already on the downslope of underperformance.

    ‘Context’ also means considering the climate we’re in and how it’s changed. You’ve probably heard the term ‘new normal’, evidence of which can be seen in a number of industries, from banking to insurance to consumer electronics and autos. What’s the new normal in active management? How has the active fund industry adapted to the new normal? You’d think that, like others, active funds would adapt, which would mean cutting fees. Suffice it to say that hasn’t happened because, as you well know, fund fees are very sticky. So, the discussion becomes very self-serving and unilateral — I charge what I charge and you get what you get and if I deliver the alpha well, then, I’m worth it no matter what I charged. When you’re selling hope, and operating from such a mindset, is it any wonder then that fees remain stubbornly high (or that investors, turned off by repeated disappointment, are doing their own version of ‘take it or leave it’, in this case leaving active funds in droves for ETFs/passive vehicles)?

    If the original author of the piece wanted to dig deeper, he might have considered the advantages that performance-based incentive fees actually confer. For instance, it inverts ‘you get what you get, investor’ to ‘you eat what you kill, manager’, which is as it should be. It brings performance to the fore, rather than wanton asset gathering, which means that the manager should have a built-in incentive to close the fund before asset-bloat sets in. This, in turn, helps ensure that subsequent investors, attracted to the fund by outperformance, are less likely to suffer the double-whammy of high fees and underperformance induced by either style (tailwind before, headwind now), luck (shined before, faded now), or asset bloat (manageably small before, unmanageably large now). Sure, the fund might still stink up the joint, but at least clients won’t have to pay through the nose for it, and provided the manager is disciplined about managing the strategy’s size it’s less likely the funds fortunes will soar and crash, wrongfooting clients in the process. That’s context.

    I respect what you do on this blog to educate investors/advisors about managed futures, not that I agree with all of it, this post being an example. (We invest in active and passive vehicles alike, so I’m not coming at this as an indexing/anti-active zealot.) Thanks.

  2. Thanks for taking the time to comment. We’ve taken a stab at addressing each of your points individually, but while your comments seem to touch on all aspects of active management versus passive investment, our defense of fees pertains to managed futures only. We’re not defending the expensive side of stock investing done by mutual funds or hedge funds, and there, the exodus you reference makes all the sense in the world. That being said…

    1. We’d contest your characterization that luck or excessive risk taking is responsible for most of managed futures over performance. With managed futures, the bulk of the programs are systematic, which means large, risky, discretionary bets are eschewed for small bets with potentially big payoffs. Now, some smaller programs attempting to make a name for themselves may embrace trading that is more risky, but those risks and that trading style should be clearly outlined to the investor prior to an allocation- they know exactly what they’re getting. Does luck play a role? Maybe… but identifying a breakout in a market like Soybeans and riding the trend seems a lot less lucky than picking the next biotech winner in our minds. And for some of the programs that have been around for a dozen years and more, when does it stop becoming luck?

    2. Your argument about reverting to the mean sort of rings true, but not in the way that you think. Historically, most managed futures programs (particularly in the trend following space), have experienced cyclical performance. While past performance is not necessarily indicative of future results, many of those programs will experience a run-up, followed by a drawdown. So while trees don’t grow to the sky (yep, another cheesy cliche), it’s also not as simple as a snap back. For more, see here: http://www.attaincapital.com/alternative-investment-education/managed-futures-newsletter/investment-research-analysis/400

    3. Investor behavior has nothing to do with whether or not the fees are justified. For our part, we’re constantly advising investors to NOT chase performance. In fact, we’ve repeatedly written about the benefits of investing in a drawdown. One example? http://managed-futures-blog.attaincapital.com/2012/05/17/managed-futures-drawdowns-been-there-done-that/

    4. We’re not sure what the “new normal” means for an asset class that does not rely on credit to finance trading, nor surging corporate profits to see returns. That being said, we have seen managers that have struggled for a prolonged period of time slash their fees to appease investors, so it’s not unheard of.

    5. We’ll agree that performance-based incentive fees do confer unique benefits in terms of self-preservation, but the closing of funds to keep assets manageable and a strategy viable happens more frequently than you’d think in the managed futures space- particularly with agricultural managers. These programs are mindful of the liquidity of the markets they trade, and because they are not looking to CREATE trends, but FOLLOW them, they are very careful about not getting too big (the good ones, at least- and that’s part of the necessary due diligence).

    All in all, we understand your hesitance about the fees on face, especially relative to the fees associated with passive stock market investments, but when our investors are trying to get specialized access to agriculture traders, they’re comfortable with the fee structure. When they look at a manager with a 10+ year track record trading client accounts, they’re comfortable with the fee structure. And even those investors who have lost money over the past few years in a bad environment for managed futures are comfortable with the fee structure if they’ve been educated on how the asset class functions. They surely aren’t chasing performance at this point; they are believing in the asset class’s ability to perform in the future. Past performance is not necessarily indicative of future results, but the point is that the performance, net of fees, and the unique performance profile of the asset class, tends to justify the fee structure for a sophisticated investor.

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.