Mallika:
Thank you everyone for joining me today, we are very lucky to have Gary Mishuris of Silver Ring Value Partners. I've learnt a lot by speaking to Gary and studying his Owner’s Manual. I know people can concentrate a lot on fees, when they're looking at fund managers, but I think they should really concentrate on aligning interests. Gary, when people are evaluating funds, what should they look for in terms of alignment of interests?
Gary:
Sure. So I would say there are three things you want to think about it. Then the three things are:
1) Can the manager build a lot of wealth for himself or herself while the investor, the client has a mediocre or worse outcome?
So that's number one, and then we will zoom in into each kind of item.
2) What behavior does the structure and the fee structure incentivise for the manager. What is the fee structure? What does it make them want to do? You know, in terms of financial incentives.
3) The degree to which they rely on quote, unquote “industry standards” or their justification for their structure, as opposed to thinking from first principles and figuring out what's fair and what aligns incentives.
So let me go through briefly each one in terms of building wealth. Yeah, the standard fee structures. There's two types right? There's the flat fee say 1%. And then there's the hedge fund structure of two and 20 or one 20. In each case you can have a very mediocre result. Let's say the investor does know better than the passive index fund, but the manager builds massive wealth. In the case of a hedge fund, it could be very quick, but even in the case of this flat 1% fee, which some people are very proud of. I'm a fee only advisor. Great. But you can still have not very good returns. Be very wealthy yourself from running your business and not have your investors really do well.
Number two is what does your fee structure incentivise? Well, let's think about it. If you have just a flat 1% fee, as an example incents one thing - asset gathering - and no matter how you spin it, the more assets you have, the more you will make money. And that asset gathering is going to pay you more than having higher returns. That's the financial incentive. It's not necessarily that we'll do that, but that's, what's pushing you to do. Now for a hedge fund. The one in 20, two and 20 also incents asset gathering, but in some ways, perhaps incense risk-taking above and beyond what's appropriate because if a hedge fund has one huge year, they collect a massive fee. And it's that short term time horizon that they've incentives focus on, which is in my view as a long-term value investor - suboptimal. And finally, the third point is when I was launching Silver Ring Value Partners, about five years ago, I heard a lot about “industry standard”. So industry standard is an adult way of saying the other kids are doing it, so I’m going to do it too.
It usually refers to things that are advantageous to the manager and disadvantages to the client. For instance, the standard practice in the hedge fund space is when you charge a management fee, to then charge hidden, not really hidden, but kind of partially hidden, expenses to the fund directly for things like audit and fund administration. A bunch of things we should do add up, especially for a moderate sized fund. And, you know, that's the raw logic and it's industry standard. Now it makes no sense. You're already charging a management fee. Why should you then charge on top of that?
It's just a way to charge more. So when you see people acting in the way that favors them at the expense of the client and using industry standard as a justification, that suggests that the person just wants to make a lot of money for themselves, not necessarily for the client. So those are the three things I would focus on.
Mallika:
Thank you so much, Gary, that was very useful I've I really learned a lot from you and your Owner's Manual.
Thanks again. Thank you so much for having me.