Am I Paying the Right Fee?
During the last three years, according to bfinance’s recent Asset Owner Survey, one third of investors have conducted an external fee benchmarking study and a further 15% plan to do so in the next twelve months. They undertake fee reviews for variety of reasons but, based on anecdotal evidence and our own experience, they can be categorised into three main groups: those wishing to discover opportunities for savings, those ‘health-checking’ fees as part of a governance and transparency programme, and those with specific pre-identified concerns who are seeking hard information and support on which to base next steps.
Source: underlying data for bfinance Asset Owner Survey 2018 “Innovations in Implementation,” which incorporates responses from 485 investors.
There is a bias towards large institutions: nearly half of investors with more than $25 billion of assets have done this, with an additional 13% indicating intent. Yet the most interesting distinctions are geographical. Central European investors are significantly less likely to have done this than their counterparts in UK, Australia and North America.
Source: underlying data for bfinance Asset Owner Survey 2018 “Innovations in Implementation,” which incorporates responses from 485 investors. Data shown for 9 largest regions by number of respondents, together comprising >80% of respondents.
Before considering the all-important question of what’s involved in different types of fee benchmarking and the extent to which they’re proving useful, it’s worth taking a moment to place this data in the context of other potentially cost-reducing measures that asset owners have taken during the last three years or plan to implement in the immediate future, as illustrated by the following chart.
Many of the most popular options are interconnected: external fee benchmarking (#3) can be used as a basis to support significant substantial renegotiation (#1) or a switch to another provider (#5), and these efforts can also be informed or supplemented by Transaction Cost Analysis (#4) – which, along with co-investment, proves to be the most popular new tactic for the upcoming 12 months.
Source: bfinance Asset Owner Survey
Yet fee benchmarking does not necessarily translate into savings. In fact, we observed no correlation between those who had conducted such studies and those who had succeeded in renegotiating significant (>10%) fee savings from managers, after correcting for critical variables such as the investor’s size (larger investors, while more likely to have conducted fee benchmarking, are also expected to carry more weight in negotiations simply on account of their present and potential future value to an asset management firm).
When it comes to conducting these independent studies, investors should pay close attention to three questions. One: what are the primary sources of data, and do they reflect what managers are actually willing to accept (and willing to accept now) as opposed to headline figures? Two: how independent is the provider, and how do they address any potential conflicts of interest that may exist in their business model when it comes to providing such information? Three, how much practical experience does the advisor have in the relevant asset classes, particularly when it comes to understanding the dynamics around the way fees are calculated, assessing the hidden costs (or hidden discounts, such as co-investment rights) that don’t sit within headline fees but make a big difference to overall leakage, and carrying out fee negotiations in practice?
While the potential sources of information vary considerably, it is important to look beyond the “rack rate” that managers will quote to those conducting surveys of their fees across various products for various tiers of mandate size. When a viable mandate is actually on the table for one of their strategies, the quoted price will often be lower than that headline figure, even before further negotiation takes place.
In addition, the particular nuances of the investor’s requirements – such as ESG considerations, regulatory constraints or style preferences (e.g. quantitative vs. fundamental) – can make a significant difference to the potential fees. Even the investor’s profile (size, region, type e.g. pension/insurer/endowment) can make a difference. For example, managers may still give lower quotes on the same strategy/mandate size to a Dutch client than an English client, simply based on their estimation of what the client may be willing to accept, or give a more favourable quote to a certain client type where they’re looking to build up business (e.g. netting a central bank investor is a valuable stepping stone to attracting other institutions of this type). Timing also matters: fees can vary based on overall investor appetite and flows, as well as the number of recently launched products, with newer strategies more likely to offer discounts and managers responding to increased competition.
The process through which the manager is chosen can also produce variation. Sellers primarily base their fee quotes on one thing: their knowledge of what their competitors will be charging for the same type of product. Institutional asset management is no different. In a manager selection process, a firm that knows they’re up against limited competition, knows who their competitors are and knows what they’re likely to charge may be less motivated to reduce fees than those who are vying for business in more uncertain, more competitive circumstances.
Fee benchmarking, as a separate standalone service, is offered by various types of firm. There are dedicated advisors whose sole focus is examining, benchmarking and, in many cases, negotiating fees. There are firms which have extensive experience in manager research and selection, offering fee benchmarking as a separate service. There are firms which not only conduct manager research and selection but also engage in asset management (fiduciary and/or non-fiduciary) which offer fee benchmarking as one of a suite of services.
The provision of other services can, if well-utilised, be an asset to a firm that seeks to advise investors on the fees they’re paying. Being on the ground hunting for managers in the relevant sectors can give a broader understanding of industry dynamics and negotiation potential. Broader practical expertise across the relevant asset classes can be helpful when considering some of the nuances noted above. In addition, simple benchmarking does not always take into account “value for money,” or the fair comparison of a manager against close and meaningful peer groups based on their strategy and team, with a view toward what the investor wishes to accomplish with their mandate.
Yet multiple service provision it can also introduce numerous conflicts of interest. The most obvious, perhaps, exists where a firm that has helped to select managers for a client is then subsequently asked to advise on the fees that are being paid to those managers. Yet there are more subtle tensions when it comes to the broad use of fee benchmarking data. For example, firms that offer multi-manager or fiduciary management services are keen to show that they are obtaining advantageous fees from asset managers and are, in turn, offering competitive fees to their clients. For these purposes, the firm may naturally incline towards a higher house view on the average/median market rate for various strategies and products, such as one based on “rack rates” rather than realistic paid/obtainable fees; these provide a more attractive comparator. Likewise, consultants that assist with manager selection tend to be keen to demonstrate their negotiation prowess, with firms claiming substantial discounts achieved and often displaying these “savings” prominently in marketing materials. Again, a more aggressive comparator can be problematic.
For investors seeking to improve overall fees and alignment, different fee structures may offer an alternative to obtaining straightforward discounts. The subject has been back in the spotlight during recent months, with several asset managers and consultants publicly advocating performance fees, including Mercer and Fidelity.
However, it is an approach that investors should handle with care. It is very challenging to create structures that are (a) effectively aligned, (b) palatable to stakeholders through all conditions and (c) unlikely to increase overall long-term fee leakage. Only 37% of investors, according to the recent survey, believe that performance fees represent an effective means of aligning the manager’s interests with their own.
Source: bfinance Asset Owner Survey
While there are structural solutions to some of the problems with PRF arrangements, those answers can create new difficulties, such as the way in which high watermarks can incentivise clients to stay with underperforming managers. An investor may also consider innovations that do not necessarily involve performance-related fees. One newer model involves caps on ad valorem charges to limit fee inflation in the event of market-driven asset growth. This has been encouraged by the bull run of recent years, but is not a mainstream practice.
When it comes to fee benchmarking, investors should watch out for the nuances of performance-related fees. Hurdle rates, catch-up percentages and other details of design make a massive difference that, in practice, often outweighs the details of the base and performance percentages. Where managers offer both fixed and performance fee structures but the investor prefers a performance fee in theory, it’s important to have an eye on the details rather than presuming that managers offering cheaper fixed fees are necessarily cheaper across the board.
In the past year, we have become increasingly active in benchmarking the fees paid by investors against sector/sub-sector averages and providing fee benchmarking data to clients. Yet these challenges, and others, have been high on our agenda. Overall, the trend towards greater scrutiny of costs, including through independent benchmarking, is undoubtedly a positive one. Yet investors should be ready to ask tough questions, spell out objectives and demand quality from these reviews.
This commentary is for institutional investors classified as Professional Clients as per FCA handbook rules COBS 3.5R. It does not constitute investment research, a financial promotion or a recommendation of any instrument, strategy or provider. The accuracy of information obtained from third parties has not been independently verified. Opinions not guarantees: the findings and opinions expressed herein are the intellectual property of bfinance and are subject to change; they are not intended to convey any guarantees as to the future performance of the investment products, asset classes, or capital markets discussed. The value of investments can go down as well as up.
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