Putting the Investor Horse in Front of the Fund Company Cart

FPA made a couple of announcements a few weeks ago that to most people would be the stuff of put-me-to-sleep reading.

The first change was that FPA cut expenses for

The changes are a lot more interesting on closer inspection, though, and even a little surprising. What's unusual about both isn't that they were made--mutual fund firms make these kinds of adjustments all the time--but that they were made with investors in mind rather than business considerations.

Standing Up to Reason Let's start with the expense ratio. Among other contributors, extraordinary central-bank monetary policies have driven global yields down so low that many hover at or below zero on a nominal basis, and they look even worse when you consider the effects of inflation. Against that backdrop, comanagers Tom Atteberry and Abhi Patwardhan have been struggling to maintain their core discipline, part of which they see as holding high-quality assets and protecting capital, while still delivering on the fund's performance objectives. Because they're not willing to compromise their discipline, they decided to cut the fund's expense ratio to keep from having to make that choice. Right now the plan is to hold the cut in place for a year and revisit it then. They would consider undoing the fee cut if the relationship between inflation and Treasuries were to normalize and yields to rise sufficiently, but if those changes don't materialize, they expect to renew it for another year.

The change to the fund's quality parameters is a little less dramatic, but it makes a lot of sense. At first blush it might look to be exactly the kind of change in discipline the team said it wouldn't countenance, since in theory one would expect securities with slightly lower ratings to yield more than those rated higher. Atteberry says they've been discussing the change for several years, though, and the logic is compelling. Rather than reacting to competitive pressures, the decision grew out of market-efficiency analysis that told the team there were times they could pick up better returns while saddling investors with very little added risk.

The managers have always drilled down to analyze underlying collateral, issuer underwriting standards, and the market's experience with those firms' defaults and loss severities, and they have a history of running from things that scare them, even when they're popular among other investors. Patwardhan says that in analyzing the collateral underpinning asset-backed securities, though, they've regularly found that the securities' single-A tranches had extremely similar risk profiles to those of their AA- tranches. Without going into deeper weeds, historical default rates and loss severities have been very close, levels of volatility have been as well, and historical price action between the two cohorts has been highly correlated. Even against the backdrop of the worst historical periods--that is, the 2008 financial crisis--the prices of nearly all the worst-hit asset-backed rating cohorts (with the exception of some at the very top) collapsed to similar levels as investors fled. Atteberry and Patwardhan don't think single-A tranches are a bargain today, but given the thesis, they want to have the flexibility available down the line.

What's Your Motivation? If these are such common changes in the industry, what's the big deal? We come across funds adjusting their price tags all the time. It's rarely a big surprise since those funds are usually on the expensive side to begin with, and the companies managing them are invariably having some trouble pitching them to clients as a result. In fact, I can't think of an example in which a fund company has given a price-cut rationale other than doing it to "be more competitive" or "get closer to the average" for a fund's category. In other words, it's about sales and marketing. Generally speaking, a fund company will try to charge as much as it can get away with, and the only reason for bringing prices closer to those of competitors is a matter of keeping or attracting new assets. The idea that one would cut fees because the market is making it difficult to do right by its clients is just about unheard of.

Likewise, the team's asset-backed pricing observations aren't really unique, and fund companies often expand their funds' mandates to include lower-rated securities. But there, too, it's almost always a question of whether the fund has the same ability to take on more risk as those against which it's laboring to compete. Once in a while the discussion also includes talk of capitalizing on market opportunities of one kind or another. What's notable, though, is that FPA turned the idea on its head by starting with market observations, an investment thesis, and risk analysis rather than fear of losing out to competitors.

The Pudding's Proof Here's the real kicker: FPA is lowering the fund's expense ratio but isn't taking the hit from its lost revenue. And Atteberry says that it won't have any effect on his team's salaries or bonuses, since he doesn't want to threaten morale. In fact, he's still planning to hire another member for the team this year.

How's he going to manage that? By shouldering the entire burden himself.

Morningstar has spent a lot of time contemplating whether managers' interests are well-aligned with those of their investors, whether by virtue of their compensation structures, the size of investments in their funds, or even ownership in their employers. Yet it's difficult to imagine a more investor-friendly act than Atteberry's decision to take a pay cut for the good of his shareholders. FPA has always been a pretty shareholder-friendly shop, and its managers good stewards of capital. Tom Atteberry just jumped over a very high bar, though, and deserves enormous credit for putting his investors ahead of himself.