|18 June 2012||Tweet|
|Investment management fees dragged down by poor performance|
A survey by bfinance of major European and global fund managers, representing £6.124bn (US$9.397bn, €7.560bn AUM) shows that fee levels are under downward pressure, particularly for hedge funds and active managed developed world equity funds due to poor performance.
Lower fees were most likely to be available on traditional US, Japan and UK equity funds, which are net losers of assets, as pension funds reduce their weightings to active management in these areas and go passive in order to reduce costs from 0.7% to 0.10% at a stroke.
A majority of respondents said that investors were getting smarter about only paying for genuine alpha and would not pay for beta, whereas there was an acceptance across the industry that investors were prepared to pay for outperformance.
Scope of survey
The survey findings are based on emailed responses and telephone interviews conducted in late May/early June 2012, with 16 UK, French, Dutch and US fund managers.
Around half of those surveyed said they were under pressure to be more flexible on fees and that there had been a move by clients towards performance-related fees, high water marks and lower base fees.
Other trends forcing down average fund management fees were the move towards passive management and increasing volumes of DC business. However, capacity constrained fund managers with strong track records of producing alpha continue to command higher fees.
Factors in fee pricing
Fee levels continue to be determined by a range of factors, but all respondents said that fee negotiations usually started from the fee rate card. Most respondents said it was hard to diverge from industry norms, although most were willing to discount fees in certain circumstances.
Respondents said fees continued to be set according to mandate size, asset class, complexity of the mandate, structure of the investment (pooled/segregated), amount of work required for client servicing, demand, capacity constraints, resources, views regarding future market positioning, peer relative price positioning, if the product was recently launched and existing/wider relationships with the client.
One respondent said: “The [fee setting] process is part science, part iterative, part market related, part analysis of the cost of production and overlaying that with a view on capacity and what the prevailing rate for a similar product would be in the market place. We would look at where we are on capacity and whether we are close to capacity, so there is a whole host of inputs. If we have a long and well established product and getting close to capacity, there would be a reluctance to offer a discount on the product against the rate card.”
Some respondents said they used institutional databases/research from Callan, Mercer, eVestments and so on and separately had pricing committees which reviewed, monitored and agreed on price positioning in an attempt to maintain price points which could be viewed as competitive within the relevant ‘peer universe’ .
Typically when a new mandate with an existing client is proposed, respondents said that the relationship manager worked with the appropriate asset class to determine the appropriate fee schedule for the new mandate. Relationship pricing level concerns were taken into consideration and if a custom fee was proposed, it was reviewed by a fee committee.
Fund managers with strong performance and capacity constraints were confident in resisting requests for lower fees. The same managers also cited Most Favoured Nation (MFN) status as a reason for being unable to offer discounts to other clients in the same funds.
One investment house said: “Because we have a large position in charitable organisations, endowments and SWFs, we are often asked for MFN status, so that they know we won’t sell the same fund cheaper elsewhere. MFNS make it very difficult to indulge in differential pricing.”
Other managers said that the competitive landscape made it difficult for a fund manager to levy fees which were clearly out of line with the rest of the market.
Final decision making on fee proposals by relationship managers tended to be taken by senior management, with sign off required, in some instances, by the head of sales and marketing, the deputy CEO and the CEO as well. Some managers said relationship managers had to seek approval from a fee committee prior to discounting below the fee rate card level.
Reasons for discounting
Respondents said that the issue of discounts on fees was not normally raised until the last minute in searches and that it was extremely rare not to reach an agreement with a potential client on fees.” Another said: “We wouldn’t enter a mandate search if we didn’t think we could agree on fees.”
Around half of respondents were willing to offer discounts in the following instances: for larger mandates (in a range of 5-15bps); if they wanted to pick up more of a particular type of client, such as local authorities; or if they were trying to build a presence in a particular type of market or an investment strategy.
However, around a third of respondents said they would be unwilling to budge on price under any circumstances due to capacity constraints and confidence that they could off load any remaining capacity at higher fees.
Emerging markets and small cap mandates were least likely to be discounted as fund managers in these areas often had capacity constraints. In some cases, fees on heavily sought after funds were actually raised to deter continued strong inflows and to protect portfolios from investment style change. One respondent said it sometimes had to close to new segregated business, cap existing segregated accounts and end pro-active marketing of its pooled funds in order to stem inflows.
New fund launches
There was general consensus that new fund launches should be offered at a slight discount to encourage new investors and to compensate investors for the risk of investing blind. A number cited use of foundation pricing for first, or early, investors because “typically everyone wants a three year track record before they invest in something.”
Factors considered when launching new products included industry demand, costs associated with launching the product, how the market was pricing similar products, product position in established or niche asset class and resource availability.
Foundation pricing varied according to asset class and the discount could be as much as 20-25% for a two year period. But willingness to discount generally depended on the individual manager’s capacity constraints.
Concentration in the DGF market, whereby around six providers have taken 80% of the assets, meant it was difficult to diverge from the 0.5%-0.75% band in this space.Pure asset managers pointed out that they were unable to offer lower fees, because unlike the fund management subsidiaries of banks or insurance companies, they had no flexibility due to a lack of cross subsidies.
Trends over past 18 months
Around half of respondents reported an increasing trend over the last 18 months for clients to challenge underperforming fund managers about their fees, particularly where they had underperformed the relevant market index.
One respondent said: “I have heard of cases where there has been consistent long term underperformance and where managers who want to keep the business have had to be sensitive as to how they can recover performance lost and a reduced fee is one way to go.”
Many respondents said that DC investors had a greater focus on TERs and that there had been a ‘pull to par’ effect on fees, with the spread between the upper and lower outliers tightening.
There was general consensus that local authorities were more likely to ask for fee reductions if target performance had not been delivered and over a relatively shorter time period than five years ago.
One respondent noted: “Historically, if you had a tough first two years in a three year mandate, the client wouldn’t have asked for a fee discount, whereas now, some local authorities ask if you can do something on fees, which is much more short term than five to 10 years ago.”
A number said that where there were very aggressive demands on pricing, they had to consider whether the business was worth taking on, if it meant servicing the client for less than passive management fees.
But apart from hedge funds, DC and developed market equity funds, pricing has remained relatively stable for niche high alpha offerings which can demand relative price premiums.
That said, one respondent commented: “There is always pressure from investors for fees that are viewed as competitive. We look to provide effective customised relationship management which leverages scalability and price point efficiencies to the benefit of our clients.”
Respondents said that where revenues had fallen in 2011, this had been due to falls in market prices in a number of asset classes, rather than loss of clients. As one respondent said: “Over the last 12 months, bond markets are up 20%, long gilts up 20% and emerging markets down 17%. Depending on your book of business, you are going to get very different fee revenues depending on what type of assets you manage.”
Most respondents reported lower overall search activity in the last couple of years, although demand for DGF, dynamic diversified fixed income, ABS, global macro, infrastructure, renewable energy and high alpha mandates remained strong. A few respondents complained that the fiduciary management services and implemented consulting offered by some consultancies were encroaching on their turf.
One respondent admitted to losing10%-20% of clients a year due to scheme mergers, insolvencies and clients taking risk off the table, but that it had recouped this business by selling to SWFs and quasi-SWFs in Asia and the Far East.
In summary, fee levels are definitely not rising and the greatest downward pressure is on hedge funds, developed market equities and DC funds, although a few respondents reported pressure on fees across the spectrum.
With fewer mandate searches in 2011and increasing scrutiny of fees, fund management groups are predicting a challenging business environment for the rest of 2012. As one respondent quipped: “Retaining clients are the new mandate wins.”