Fees have declined significantly in a number of asset classes since 2016. According to the latest report from specialist investment consultancy bfinance ‘Investment Management Fees: Is Competition Working’ there are particularly noticeable reductions in sectors where industry developments have strengthened price competition. For example, an expanding manager universe, weaker investor demand, greater visibility on overall costs and the emergence of comparable-but-cheaper strategies have all had an impact.
Fund of hedge fund fees have fallen by more than a quarter since 2016, followed by absolute return fixed income, where median management charges have declined by 15 per cent. Other areas demonstrating the downward trend include emerging market debt (-10 per cent), emerging market equity (-6 per cent) and certain niches of the private market investment landscape such as European open-end real estate (-12 per cent). The published figures are based on actual fees quoted by asset managers for live competitive mandates from investors – not surveys or ‘rack rates,’ which tend to be somewhat inflated.
Private market strategies have been among the most resilient from a pricing standpoint, with a wall of money continuing to chase private equity, infrastructure, private debt and other illiquid investments. Yet pricing trends here are considerably more opaque due to the complexity of fee structures. For example, while management fees appear to have declined slightly in certain private equity strategy types, we have observed reductions in hurdle rates which may, depending on future performance, leave investors shelling out more than before. We also see some managers hiking their pricing tiers, meaning that an investor is expected to make a larger commitment than before in order to obtain the equivalent discount.
In addition to the visible costs – management fees, performance fees, administrative fees and so forth – payable by investors, private markets also exhibit particularly high ‘hidden costs’: leakage which may not show up as a visible expense to investors, such as certain property charges in real estate.
Fee trends are always of interest, not least because sector-wide declines can present a broad opportunity for investors to renegotiate improved terms. Yet there are many other ways of obtaining better value for money on a case-by-case basis, even in asset classes where average terms are not improving overall. Many of these approaches essentially involve finding ways to create or re-frame the contest between asset managers, such that the investor can become a price-maker rather than a price-taker. The investment management industry is not one in which price competition functions efficiently. Yet in an imperfectly competitive market competition can be encouraged, enhanced and even engineered.
One approach that we see more investors pursuing is more granular, detailed benchmarking of the fees they’re paying. Rather than relying on high-level asset class averages and survey data, there is growing demand for comparison against more specific manager peer groups which also takes into account the investor’s region and type, as well as the current fundraising dynamics. Newer techniques for performance analysis, such as risk factor attribution, can also be helpful in obtaining an understanding of whether a manager’s fee can be considered fair and appropriate, helping investors to understand whether they’re paying for what they would consider ‘real’ alpha.
A second route that has proven popular in recent years is mandate consolidation: awarding larger sums of money to fewer managers. While this can generate savings, tiering patterns vary greatly depending on the sector. For example, while global active equity investing offers consistent price reductions between $50 million and $500 million as mandate sizes increase, global fixed income discounts become far less substantial north of the $100 million mark. Conversely, significantly larger mandates are required to extract meaningful scale benefits in certain illiquid asset classes.
A third approach, and one that has been heavily advocated by some consultants and asset managers, involves moving towards fee structures that may theoretically improve alignment between investor and manager. For example, recent years have seen the rise of some more aggressive performance-heavy fee structures for active equity, with proponents arguing that anything beyond a near-passive price should be based solely on outperformance. Good PRF alignment requires complex implementation of caps, floors, high watermarks and more, as well as appropriate cultures and incentive schemes among portfolio managers. To adapt a familiar idiom, culture eats structure for breakfast. Executed poorly, PRFs can create more problems than they solve. Other adjustments that may improve overall efficiency include greater use of alternative access points such as co-investment or direct investment.
Finally, investors can consider how best to encourage price competition when selecting and reviewing external asset managers. The reality is that institutional manager selection activity often does not allow managers to compete effectively on price. For example, investors and consultants may employ relatively narrow manager lists, or may not address the issue of price until the field has been whittled down to a small handful of contenders. Managers frequently express frustration that they do not know how various strategies are priced relative to their peers. Running open searches with a broad universe of providers vying for mandates can enhance price competition, as can tackling the subject of costs with managers earlier in the process rather than leaving it until the final hurdle. Understanding total costs (not just fees), including hidden costs, helps investors to compare providers more effectively.
Above all, notwithstanding interesting developments on the fee front, it is important not to let a focus on price overshadow the bigger picture. Pursuing cost reduction with insufficient regard for investment outcomes can be a dangerous pursuit. Net return – not price – is the most important metric.
This article includes data and material from Investment Management Fees: Is Competition Working? (bfinance, 2019). The full report can be found here.
Kathryn Saklatvala is director, investment content and thought leadership at bfinance