At Focus Capital Management, the Manager is paid no management fee whatsoever, only an incentive fee of 25% of profits. And if the Fund goes down the first year, there is no incentive fee until after we have returned to the previous high water mark. We don’t make money unless our investors make money.
We don’t want to simply be asset gatherers. Often, it seems that managers build something of a track record and then open the fundraising spigot, massively boosting the size of their fund even while returns stagnate. Because that’s where the money is, that’s where their incentives lie. We, however, have little incentive to raise assets if it will hurt our performance, because we are paid solely based on our performance. If and when we judge our strategy to be within 30-50% of capacity, we intend to close the Fund to new capital so as to preserve years of runway to invest and grow the capital we already have.
Although many managers profess to be long-term investors, the realities of the business make it very difficult for them to follow through. It is very difficult for them to keep their eyes on the long term when they are constantly scored and compared on a short term basis. Managers know that if they underperform over a few months or quarters, they can face sizable outflows from their investor base, and, consciously or subconsciously, they react accordingly. Even the (fewer and fewer) funds that feature lock-ups almost universally allow withdrawals on an ongoing basis once the lock-up expires, so that for the vast majority of the invested capital the lock-up is not in force. We believe that the short-term focus engendered by misaligned incentives is a major contributor to why many managers underperform over the long term.
To combat this and to properly align incentives to encourage long-term investing, we have structured Focus Capital Management with renewing multi-year lock-ups. Capital invested in the Fund remains locked up for two years and is then eligible for withdrawal at the end of the calendar year. (So for someone investing on January 1st, the lock-up is 2 years, and for someone investing on February 1st, the lock-up is generally 2 years and 11 months.) When the capital is eligible for withdrawal, if the investor chooses to remain invested in the Fund, the capital is again locked up for another two years, and the high water mark resets. With this renewing multi-year lock-up, both the Manager and the Investors remain focused on what really matters — long-term investing. We believe our ability to arbitrage the market’s incessant focus on the short-term future with our patient long-term focus to be one of the strongest advantages we have when investing.
As a further corollary of our insistence to focus on long-term investing, we eschew providing monthly account statements in favor of reporting quarterly. This balances the understandable need to keep investors informed on the performance of the Fund with the desire to de-emphasize short-term fluctuations in favor of long-term investing performance.
