Are managers rewarded for fee alignment?

Albourne Partners, a leading consultant focused on alternative investments, has been an advocate for fee innovation in the investment industry for many years, focusing on the shape of fees, and fee discovery and transparency.

A recent review by the firm that examined the manager performance and mandate activity post fee changes, showed that managers are being rewarded for fee innovation.

John Claisse, the firm’s chief executive said there was also a relationship between manager performance and willingness to be flexible on fees.

“We looked at managers that had a collective 189 different fee changes made over the last two years, and our research showed that from the point where those changes were made 70 per cent had a positive trailing three-year return, so it was not necessarily managers that were already underperforming,” he said in a Fiduciary Investors Series podcast. “In addition managers were rewarded with positive capital flows where there were loyalty discounts or aggregate discounts across a consultant or size of allocation.”

Albourne has been looking at the shape of fees since 2012 for its clients – which include Teacher Retirement System of Texas, BT Pension Scheme and Regents of the University of California – that collectively invest more than $550 billion in alternatives.

This started with an investigation into what they called “the angry dollar” where investors were paying for performance but analysis showed it was coming from beta. At that time it launched the Feemometer which encourages more open dialogue about fees and how to get better fee arrangements.

Perhaps most notoriously Albourne worked with Texas Teachers which implemented a 1 or 30 approach to alternative manager fees. This structure means the client pays a 1 per cent management fee or a performance fee of 30 per cent of alpha, whichever is greater. However, following periods when the 1 per cent management fee exceeds 30 per cent of alpha, an investor pays less to bring its share of alpha back to 70 per cent. Essentially, when alpha is not sufficient to cover the 1 per cent management fee, that fee is paid as an advance on future performance fees, and Claisse says the structure has revolutionalised the conversation around fees.

“It was designed at the time to focus on the shape of fees, to make sure investors were thinking about participation in the profits, alpha generation of a manager, and making sure they’re paying for skill,” Claisse says.

The consultant also launched Into the Matrix initiative in 2016 which among other things scored managers on their fee transparency and flexibility. It also allowed managers to post open and closed proposals to investors on specific fee deals as part of a match making service between asset owners and managers.

“We spent a lot of time thinking about the shape and discovery of fees rather than the level, and wanted to give investors a better understanding of the options available,” he says. “We are gathering data from 750 funds with over $600 billion in assets, who are answering surveys about what types of fee structures they’d be willing to look at and be flexible with. From that comes a score on flexibility and transparency. There is a tradeoff with a manager who is being inflexible but very transparent about that. We want to know when a manager is flexible but not transparent, that is not best practice.”

Once the data is collected, it is possible to look across the universe at equivalent funds and what they are charging, and what it would be like if an investor was working with a different manager.
Albourne, which takes a fixed fee for its services, has been advocating for better practice within the alternatives industry for many years and in addition to issues of fee discovery and transparency has also recently been advocating for new initiatives around diversity and inclusion and how alternative investment managers can incorporate ESG.

“It is clearly a challenge for the investment industry and so many parts of society to address some significant systemic inequities and how that is translated into different industries.”

Albourne, in conjunction with AIMA, launched a due diligence questionnaire that focuses on diversity and inclusion and builds on the work the consultant has been doing to identify women and minority-owned firms.

“With ILPA’s blessing we worked with AIMA to expand the reach of their questionnaire to gather data around workforce diversity as well as ownership, and insights into family friendly leave policies and staff conduct information,” he says, adding that LGBTQ+, veteran status, disabilities and minorities are all considered topics.

“This builds on what we’ve been doing elsewhere in ODD for several years around equal pay, and the D&I policies and practices of managers. Now we are encouraging managers to share this data – I’m really hopeful this will have a material impact on how managers approach D&I within their businesses,” he says. “We’ve had phenomenal feedback about the questionnaire and already more than 400 funds that have submitted the questionnaire.”

He says both managers and investors are responding well to the increased focus on diversity and inclusion.

“The feedback from investors is they have been struggling with how to gather the data, so having a standardised template for them is helpful. On the manager side our preliminary feedback has been positive, it is helpful in triggering their own work internally and new policies in response to thinking through the questions and enhance their own D&I.”

Claisse says in the current environment investors are looking for more consistent returns and there has been an emphasis on relative value or global macro managers that are a greater diversifier, and to be consistent in returns.

According to the firm’s alpha profiling tool, most strategies were performing well before the crisis, then experienced significant losses but have recouped those negative alpha experiences since, with structured credit the outlier.

“If you look at alpha generation more recently, say year to date, stock picking outside of the US has been the strongest, then global macro and fixed income arbitrage,” Claisse says. “Hedge funds don’t have a divine right to exist. A lot of underlying strategies are cyclical, so they need to pay attention to the environment and adapt.”

Most managers have managed the working from home environment effectively from an operational perspective and in some cases investors are actually getting more transparency, he says.

“You lose something by not being on site, but the investor access to the risk takers and information is actually improved. It’s a strength of the industry that managers adapted their processes.”

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