It occurred to us that in our entire 16 year history we have never formally communicated the evolution of our beliefs on appropriate fee structures within the investment management industry and how this has informed our own somewhat unique approach to fees.
We decided now was as good a time as any to set out our beliefs in writing — to initially benefit the understanding of our own loyal clients but hopefully and more importantly to convince others in the industry of the merits of our approach.
Our primary goal at TDM has always been to generate outstanding returns for a small group of loyal clients over the (very) long term. We do this by “investing in and helping businesses we’re proud of”.
However, in the process of investing successfully, we also want to leave a lasting mark on the way the investment industry and businesses in general operate. We are passionate about a number of topics in pursuit of this objective, including: creating and sustaining effective boards and high performance executive teams, the importance of culture to business performance, the benefits of long term thinking, and of course the subject of this blog — the fees and incentives in the investment management industry.
In 2004 when TDM was started on the floor of Tom’s apartment, the fee structure reflected the same key principle as it does today — if we perform well for clients we can get paid well and if we don’t we can expect close enough to zero.
This principle manifested itself in a very simple fee structure at TDM’s inception. We would earn 15% of the profits clients made. If the clients made zero, we made zero. This was in stark contrast to the typical fee structures deployed by other investment firms running concentrated portfolios of investments and targeting 20%+ pa returns — such as hedge funds and private equity funds, who routinely charged and continue to charge a yearly 2.0% management fee in addition to performance fees. While public equity funds targeting lower returns generally had smaller or no performance fees, they too charged significant management fees which would be collected on the back of performance which was often no better than market benchmark. When one takes a step back its clear — the vast majority of the investment management industry is able to collect significant fees for either losing their clients’ money or performing no better than a passive market index.
During the Global Financial Crisis, a few of our clients came to us and told us that they were concerned that we couldn’t fund our operating costs during the downturn and wanted to make sure we could survive long enough to get through the downturn and continue to invest for them. We were only a company in its infancy, and none of us had any personal financial security. We needed to keep the lights on, even though at the time it went against our deepest belief in regards to the alignment of incentives of agent and principle. Eventually we found some middle ground.
Aside from demonstrating what a unique and unbelievably supportive client group we have, this development resulted in the invention of what became labelled our “rebate-able” management fee. The clients suggested they pay us 1.5% per annum as a pre-payment of performance fees to provide a smoothing effect on our cashflows. We accepted this proposal and it’s reflected in the fee structure we have today — a performance fee and a 100% rebate-able management fee to help us manage our operating cashflows. The rebate-able fee is also capped at the operating cost of the business.
The only error we made in hindsight was our labeling. We chose at the time “rebate-able management fee” without really thinking very deeply about it, but really as it’s simply just a pre-payment of future performance fees. We recently changed the name to reflect this. All of the management fees our clients pay over time are deducted from any performance fees owing— hence in the long term we only get paid on performance.
In addition to performance based fees, we are equally passionate about transparency. A key tool we use to achieve transparency is our Individually Managed Account (IMA) investment structure, which has been in place from day 1. Each client (or their chosen entity) has direct ownership interests in the companies which comprise the TDM portfolio. This is in contrast to the typical funds management vehicle which operates in a unit trust structure, where a single vehicle owns all the investments and clients have an interest in that vehicle.
The IMA structure allows clients full visibility into every dollar that is invested and spent on their behalf. At any point in time a client can see their exact portfolio as well as each and every expenditure item. In what seems to be a great example of “what gets measured gets managed”, this creates a huge discipline for us in terms of what expenses the client pays and what we, as managers, pay. Across the funds management industry generally you might see expenses borne by the client outside of management fees of up to 20 basis points per annum (for audit, legal, and other administration expenses) . In contrast, TDM’s belief is that these fees should be paid for by the manager, by default, with any exceptions specifically communicated to and agreed by the client.
So why write a memo now after 16 years of just doing what we do?
Certainly not to convince new clients to join, we are currently closed to new investors. Its because we think performance based fees and 100% expense transparency should be the bedrock of the investment management industry (and in fact corporate incentives more generally) and we hope that what we believe passionately in will become much more common across the industry in the future. We simply have a belief the investment management industry can do better.
If you have any questions, or thoughts, as always please reach out. You can find me on LinkedIn here