bfinance: Fees Falling Across Asset Classes, Yet Overall Investor Costs Still Climbing

May 16 2017 | 9:53pm ET

Despite unprecedented attention on fees, new research from investment consultancy bfinance reveals the average pension fund is paying out a higher proportion of their AuM in investment costs than they were ten years ago despite declines in fees across several asset classes.

The pressure on costs is visible in bfinance’s research: global active equity fees are down 8% (24% for low volatility), smart beta fees down 25%, fund of hedge fund fees down 20% (30% in Europe) and private debt management fees are down over 30%. Nonetheless, greater allocations to private markets and new breeds of premium product have fueled overall cost increases, on average, for sophisticated investors, bfinance said in a statement. 

The core takeaway is that investors can exploit recent fee reductions in specific strategies and sectors to improve value for money. 

The study, named “Investment Management Fees: New Savings, New Challenges,” reviews three fee-pressuring trends bearing down on fund managers: a climate of mistrust following the global financial crisis, greater understanding of various betas dressed as alpha, and a low-rate climate. As future performance is increasingly seen as uncertain, it points out, cost reductions have become an important new metric and investors are seeking savings through switching investment strategies, bringing functions in-house or negotiating with vendors.

KEY HIGHLIGHTS OF BFINANCE's REPORT

1) Active global equity fees are surprisingly resilient, falling just 8% since 2010-2014 despite intense pressure from passive and smart beta products.

The reports finds that active global equity management fees have fallen by a meaningful amount, but the fee reductions in other sectors such as smart beta (down 25% since 2011) and low volatility (down 24% since 2010) have been far greater. The authors suggest a number of causes for this resilience, such as the transparency relative to other sectors (causing a tendency to cluster around known average fees) and the trend to position active offerings as complementary to systematic strategies rather than competitive. Managers have focused on metrics such as idiosyncratic risk exposure and active share, to distinguish themselves from smart beta and passive funds respectively. Also in equity, investors shift from performance fees towards management fees and explore new structures such as flat rates.

2) Fund of hedge funds have cut fees dramatically. Average management fees of fund of hedge funds have fallen by 20% globally and nearly 30% in Europe since the 2010-2014 period. The challenge to attract asset inflows into FoFHs has been made more complicated by the evolution of alternative beta and the growing popularity of various multi asset or diversified growth strategies.

3) Private markets present a difficult picture, with managers often holding the upper hand. Private market manager fees have remained high, particularly in infrastructure and private equity, and have even worsened in some cases, with too much money chasing the available supply of opportunity. 

“Why have certain very popular private equity managers done away with hurdle rates? The answer is very simple: because they could,” says Anne Feuillen, senior director in bfinance’s private markets. “But this has a meaningful negative impact on net returns and reduces the alignment of interests between GP and LP. It is very hard for investors in this fundraising climate to say no, that’s a step too far.”

4) Base fees at private debt strategies have fallen by more than 30% since 2014. Private equity fund of funds, particularly those focused on primaries, have also become significantly less expensive. 

5) Despite falling fee levels across a number of asset classes, total fund costs are rising. Despite these falling fee levels, data from CEM Benchmarking shows that total fund costs of the institutions in their database have risen from 37.8 bps to 57.3 bps over the past ten years. A significant factor in this trend is the growing demand for illiquid investments and alternatives. Another factor is the launch of more expensive funds in public markets: unconstrained, absolute return, asset allocation or advisory products have proven increasingly popular. 

6) New consultants and services have emerged to help investors reduce fees. A plethora of new providers have emerged to service the cost reduction mission, encouraging a deeper understanding of underlying processes such as transaction fees rather than relying purely on benchmarking and price comparison.

TAKEAWAYS FOR INSTITUTIONS

bfinance's report offers three takeaways for investors: renegotiate, reassess and reprioritise. Where significant price reductions have taken place, now may be the time to bring providers back to the negotiating table and get fees in line with new practices. If fees proved to be a crucial factor in investment strategy, such as the choice of single hedge funds versus FoHFs, it may be worth examining the question again. Finally comes the question of priorities: stakeholders should always remember that, while asset allocation is always preeminent, implementation risk is increasingly critical to investor outcomes for today’s more illiquid and expensive portfolios. Asset allocation strategy and implementation reality are not always aligned and bfinance advises that the conflicts between the two should be recognised and governed rather than ignored.

The research solicited comments and contributions from numerous investors around the world, including Canada, Australia and Europe, bfinance said. One case study from BT Pension Fund in the UK shows how this investor reduced its fees by 25%, without sacrificing diversification or giving up its commitment to active management, through better benchmarking and monitoring, fewer and larger mandates, strong fee negotiation with a pressure on excessively generous “alpha share”, a movement away from performance fees and the introduction of fee caps.

“We are pleased to be able to share this data, showing fee reductions in particular sectors including global equity, fund of hedge funds and private debt, as well as giving some insight on less well understood areas such as unconstrained fixed income,” said Kathryn Saklatvala, global content director at bfinance and the report’s principal author, in the statement. “There are fascinating trends going on, particularly in global equity where active management fees have been surprisingly resilient in the face of intense competition from smart beta and passive funds. Yet there’s a clear bifurcation, with cost reductions in products with strong factor exposures, such as low volatility active management.”

“Publishing information on fees quoted by asset managers, as well as negotiated discounts, can help to promote the interests of asset owners,” added David Vafai, CEO at bfinance. “But it is important to remember that visibility can be a double-edged sword: while benchmarking can help to ensure that investors don’t over-pay, it may also make managers less likely to offer prices significantly below the average.” 

London-based bfinance is an investment consultancy providing specialist advisory solutions to institutional investors in 25 nations worldwide. These include strategic investment implementation, investment strategy design, investment manager search and selection, due diligence, analytics and monitoring.


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