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Rather than be swept up in the rush toward low fees, it might pay to do a little homework and be open to new ideas.NicoElNino/Getty Images/iStockphoto

Money managers are facing a revolution. Their business was built on fat margins, yet suddenly they've found a new religion. The new gospel: low fees, by any means necessary.

Signs of the shift are everywhere. Low-cost, exchange-traded funds are in favour, and everyone from AGF Management Ltd. to Mackenzie Financial Corp. is launching its own suite; Royal Bank of Canada, Canada's largest money manager by assets, is now advertising its bare-bones mutual-fund fees in order to lure clients; and pension funds around the world keep slashing their exposure to expensive hedge funds.

It all makes sense. Many investment managers have failed to prove their worth over the long term – particularly hedge funds, which made hundreds of millions, even billions, of dollars in good markets, yet rarely suffered along with their clients during bad times.

It's also hard to justify lofty management fees when yields have plummeted, driven low by rock bottom interest rates.

But amid the rush to sing from a new hymn book, hardly anyone is stopping to ask whether low fees are always the best approach.

Craig Bodenstab is among the few who questions the new orthodoxy. His Bermuda-based firm, Orbis Investment Management, manages roughly $30-billion (U.S.) for 150 institutions globally, including some Canadian shops. Its compensation model is atypical: One option is for clients to pay performance fees when the fund does well, and for Orbis to refund money when the fund misses its benchmarks.

Hedge funds, meanwhile, typically deploy the "2-and-20 model," charging a 2-per-cent annual management fee and also taking a 20-per-cent performance fee for any profits above a certain threshold. In years when the funds lose money, they don't return anything – actually, they still make the annual fee.

As Orbis's profile grows, Mr. Bodenstab says it's interesting to see how investment committees at some of the world's most sophisticated asset managers react when they learn about his company's pay model. Some firms have so fervently embraced the new low-fee mantra that they are quick to dismiss anything else – even something as smart as the refund approach.

He gets the frustration. Choosing a fund manager is incredibly difficult because there are myriad variables to weigh – past performance, asset allocation, risk tolerance, to name a few.

"Picking managers is much more difficult than picking stocks. You're trying to make an investment in intellectual capital," he says over an early morning coffee at The Gabardine on Bay Street.

Because there are so many variables, it's easy to resort to fees as the deciding metric. "Clients are smart enough to say, 'I may not get this right, let me at least have low fees.'… And there's some merit to that," he says.

But he cautions them: "Just be careful what you ask for. It's a little bit like saying, 'I just want to buy the cheapest suit, or the cheapest shoes.'… At some point, price and quality overlap."

Mr. Bodenstab isn't so much pitching me as he is fretting about the future. Sales really isn't part of Orbis's business model – no one at the funds gets paid commissions. "Word of mouth should be how clients generally find you," he says. He's mostly alarmed at the power of herd mentality and at how quickly people tune out ideas that aren't mainstream.

He likens it to picking blue-chip stocks. "If you buy IBM, you're probably not going to get fired," Mr. Bodenstab explains, even if IBM's performance lags the benchmark. But if you bet on an emerging company, or a unique fee model, people are quick to point fingers if it proves to be a bad bet.

"I'll never forget it: One of our larger clients said to me, 'Look, Craig, you don't understand – you pose career risk to me.'"

Philosophically, it's hard to argue that lower fees, on principle, are a bad thing. The results of hedge funds underperforming their benchmarks are well documented by now.

However, the investment management industry has a long history of playing copycat. Middle-of-the-pack managers try to replicate what the top performers, or the biggest names, do, yet simple math dictates only 25 per cent of funds can be in the top quartile of returns.

"Wall Street is a selling machine," Mr. Bodenstab says. "There's probably no industry where more people add no value, but they're paid amongst the top in the world."

All he's suggesting – rightly so, I might add – is that there are exceptions to that rule, and rather than be swept up in the rush toward low fees, it might pay to do a little homework and be open to new ideas.

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