Introduction
Fees have increasingly become a focus in the investment management landscape in Australia. Fee structures can make or break independent ratings and often dominate marketing meetings. Gateway believe that there needs to be greater discussion and transparency around fees – with particular regards to after fee performance and performance fee structures. In many cases investors are actually getting something for the fee paid. This Insight looks further at this debate.
Two important points need to be made regarding investment management fees:
- Fees are one part of an investment story. Whilst lower fees are a goal for any service purchased, there are other factors to consider when assessing a fund manager. For example, are you paying for access to successful investors with long track records or for a global network of research, or for a sophisticated data screening system – all of these come at a cost.
- Fees are part of a much wider debate which includes the value of active management versus index funds and the cost of alpha versus beta.
Where is the debate at now?
The David Murray led Financial System Inquiry released last week in Australia has shone a light on the high costs in the superannuation system, fees paid to active managers have been scrutinised as a way to strip out costs from a pension system considered one of the most expensive in the world.
But it’s not just Australia where the trend towards lower cost more passive investments is gaining traction. Globally, the portion of equity investments held in passive funds has doubled from 15 per cent in 2005 to 30 per cent, according to Nomura Research.
In the US active fund managers have seen almost $US 1 trillion of outflows while low cost exchange traded products or ETFs continue to gain popularity. According to Morningstar passive investing has now become “the mainstream approach” with only 32% of new money flowing into active managed mutual funds compared with 68% into low cost ETF and index tracking funds. Meanwhile a British government body has called on 89 pension schemes to divest their active investments in favour of passive strategies to lower fees.
What do you get for your money when you pay for active management?
Investment into an actively managed fund/IMA should include:
- Superior returns over the index
- An investment philosophy which is well thought out and makes sense
- An investment process and portfolio construction approach which has a proven track record
- A team of experienced staff who can anticipate and react to market impact events
- Research and data to form the basis of investment decisions
- Investment in a successful outcome (in the form of equity or incentives)
According to the AIST Investment Management Fee Research Report[i], by definition, only 25% of managers will have exhibited “top quartile” performance over whatever period the market measures returns. The most sought-after managers (those with a perceived long-term track record of good performance) will form an even smaller group; perhaps only 10% of the universe of all managers (for a particular asset class). Competition is therefore directed toward capturing one of the “best” managers in the first instance, with price being determined by the relative faith in the manager’s ability to deliver promised performance. Another way of putting this is that there is a price premium when a perceived competitive advantage is not replicable (i.e. some managers are better than others for reasons that can’t easily be copied).
The AIST Report also says that “Investors are buying a “promise of future performance”, their faith in the manager being determined by a combination of track record (i.e. past performance) and an understanding of the manager’s “process”, expertise and key staff members”.
Active or Passive?
- We question the notion that passive investing is safer than active investing: Passive is by definition 100 per cent of the market down-side and there are many active strategies which minimise down-side volatility. So reduction in fees does not necessarily equate to a reduction in risk.
- Even in the case of passive management, some funds require “tailored” arrangements, such as enhanced equity strategies, individual mandates or ESG (Environmental, Social and Governance) approaches and therefore justify the fees being charged. To add to that even a “pure index” product has to take account of tax, and there is scope for the manager to add value by better tax management to produce an optimal after-tax, after-fees return.
- A combination of passive and active is where many planners are likely to end up.
What does this mean for active fund managers positioning their products?
- The focus on fees means it is important you explain how value is being delivered for the cost entailed.
- A more transparent and thorough approach to explaining fee structures will help – always think about how the client will access the value add and whether you are delivering value for money vs a more passive alternative. Talk to the value add – research process and experience of the team, travel, databases resulting in outperformance ie. make the benefits tangible to the investor.
- Base fees should be considered with reference to the competitor universe and preferably sit comfortably somewhere in the middle, outliers on the high side will be viewed negatively.
- Performance fees are widely accepted in the market and in many cases preferred but we would recommend any performance fee should be over a reasonable hurdle with a High Water Mark in place, with no reset option.
- Be cognisant of other fees investors need to pay to invest in your products such as platform fees.
At the end of the day, fees are heading lower and your business needs to be prepared for this by doing the following:
- Review fee structures and vs competitors
- Know where you sit
- Review marketing messages around your fee structure
- Provide transparency and demonstrate value add wherever possible
[i] http://www.aist.asn.au/media/43411/aist_research_report_webv.pdf
