Initially, we must distinguish between advisory and management fees. Investment advisors mostly provide a service of making suggestions to their clients regarding the purchase or sale of publicly traded stocks and bonds. The suggestions are more likely to be the names and reasons for the action being recommended, rather than specific amounts relating to the client’s investment holdings. It’s usually a form of “buy X or sell Y” because it’s going to go up or down, usually in the immediate future.
It is usually a numbers game, as the advisor is making the same advice to all those in his universe of listeners or readers and within a relatively same period. The immediate result, depending on the persuasiveness of the advisor, based on prior predictive success, is somewhat self-fulfilling as the recommendation will create activity in the same security. However, once the recommended buying or selling lessens or ends, the normal market pressures will be reasserted.
Some investment advisors have records of thoughtful and successful recommendations, many do not.
Many years ago, the senior partner of the then largest investment management group in Edinburgh asked me the following life changing question, after I had pitched buying a particular stock. “Mr. Lipper, if you are as smart as we think you are, and this is why we do business with your firm, why are you not already rich?”
I thought for a minute and responded “Sir, that is a fair question and I will never again recommend that you buy a specific stock,” It was at that moment I changed my entire approach to serving institutional investor clients to providing data and a relative valuation service called “Perspective”, which became the basic product of my first New York Stock Exchange member firm. This sage, leading member of the Scottish investment trust community, perhaps then the best in the world, was why didn’t I get rich by raising money and following my own investment advice. Of course, in those days the average NYSE commission was $.62.5 cents a share so being a successful institutional service provider was well paid.
Investment managers have a very different set of functions and responsibility. The primary difference is they must be ever aware of when to sell that which has been bought and is in the portfolio of the fund or a managed client account. Of course, they must also make decisions as to the relative size of holdings, including cash.
The investment manager is judged on the performance of the portfolio and not, as the investment advisor, on how much the last recommendation went up or down after the recommendation was made.
The investment advisor can benefit from fees paid for the advice or less honestly by an undisclosed taking of a position in the security prior to making the recommendation and benefitting from the prompted action of those advised.
The investment manager receives a fee which can be fixed, performance-based or a combination of the two. It is usual that the more successful the investment manager the more assets will become subject to his or her management.
That which distinguishes between the advisors and managers are the functions. Advisors recommend an action, whereas managers make the decision and take the action regarding portfolio acquisitions and liquidations. Stated more curtly, the manager is paid to be responsible for both buying and selling and all in the best proportion for the client. The advisor just advises.
The role of a manager of a diversified royalty income fund is much simpler than that of a stock or bond fund because there are not any of the market volatility or valuation issues that stock or bond managers much be constantly aware of and in sync with to achieve superior relative performance.
The royalty income fund manager must initially assess the risk of the prospective royalty issuing company failing to be able to honor its obligations and also the reasonableness of the company’s projection of revenues. Once the position has been acquired the monitoring process is one of tracking the company’s revenues and being assured that the required revenues are being collected and distributed. We recommend in royalty funds there be a restriction that, at the time of acquisition, no royalty, from a single royalty issuing company, exceed 5% of the portfolio.
It is important to understand that the investor in a royalty income fund primarily, if not only, is interested in receiving increasing cumulative income payments, distributed quarterly. Therefore, from the royalty income fund manager’s perspective, royalties are ideal portfolio holdings because once the cost of individual royalty holdings has been recaptured there is no capital risk and the expectedly rising income continues until the end of the royalty payment period. The only “sell” decision required of the manager is in the instance of there being a tender or some other opportunity to sell specific royalties held in the portfolio.
The royalties we recommend are expected to have royalty payments recapturing most of the investment by the end of the 5th year of holding, with there being an additional 5 to 15 years of royalty payments due, commencing on the completed repayment of the loan.
In the case of the royalty issuing companies seeking the lowest cost of money we recommend that our REXdebt-shareRoyalties.com approach be considered. In this approach the company is loaned the agreed amount on comercial terms, with quarterly interest and amortization payments resulting in the loan being fully repaid at the end of 60 months, The interest rate charged is recommended to be between 120% and 150% of that which a commercial bank would charge a prime customer.
Banks typically do not make term loans to privately owned companies and usually require the personal guarantee of the company’s loan by the business owners. Banks even usually require personal loan guarantees for privately-owned company revolving lines of credit. We do not recommend that royalty investors require a personal guarantee.
However, as indicated above, we do recommend that on the repayment of the loan, a royalty payment of 2% of revenues, perhaps declining on the cumulative payment of agreed amounts, commence. There can and should be an issuer’s royalty redemption right, because even a modest royalty on the level of revenues projected by the issuer, should be very significant. The REXdebt-shareRoyalties.com website calculator allows users to set terms and see the results if the revenue projections are achieved.
Of course, the recommended policies will be different if the investors prefer companies in selected industries, characteristics, backgrounds, level and growth of revenues prior to buying a royalty, etc.
We recommend the royalty income fund management entity receive a fixed fee of a percentage of the initial assets under management plus a performance fee of a percentage of the income received by the fund shareholders over an agreed annual average market measure. In other words, the recommended performance fee is only a share of the excess over that which the investor might have obtained without any benefit of the manager’s skill and efforts.
Therefore, if the objective of the investor is to receive income increasing as the revenues of the portfolio held royalty issuing companies increase, a royalty income fund is a logical place to invest funds. Likewise, if an experienced investment manager has an ability to determine the likely sustainability of royalty issuing companies and trend of their revenues, the creation and management of a royalty income fund should be an objective.
Arthur Lipper, Chairman
British Far East Holdings Ltd
858 793 7100
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