Fees and margin squeeze. It’s the catch cry of the wealth industry, particularly with fund managers. Barely a week goes by without someone announcing fee reductions.
But, while it may look like a reduction and that margin squeeze is going on – there’s a good case for arguing that the managers may have been overpriced in the first instance or have not delivered the goods in terms of value.
Managers are blessed with a variety of new collection vehicles these days and can harness new revenue and even put in performance fees to reflect the changing world. So it’s not all bleak for them. It’s not quite the margin crunch that’s constantly bemoaned. In short, crying wolf may prove dangerous when fees really do have to come down.
It doesn’t matter what industry, all providers are increasingly pressured to substantiate price value. With technology stepping up to replace many manufacturing and distribution costs it’s hardly surprising we have fee pressure.
But it’s not always margin pressure that we are observing. It’s often times more the realignment of customer interests where everyone shares in the benefits of scale, not just the supplier. Perhaps we can thank Google for the clarity of that.
Looking at a couple of examples with what’s happening in the broader wealth management market, I noticed with interest a quality international manager advising that they were reducing fees in their flagship fund – a unit trust, while simultaneously re-arranging the fee options to include performance based fees. It seemed fees were on the way down but was the revenue pool impacted?
In reality, the original fee was, by today’s standards, excessive relative to peers. Secondly, the manager has disappointingly underperformed for that fee. In days gone by there was less competition and less of an issue because of its outperformance. Roll the clock forward and reality hits: more competition, lower manufacturing costs and consumers are more savvy about low-cost options such as ETFs.
So it’s not about fees; it’s about delivery of value for those fees. In fact, introducing performance fees is clever, if not cute, particularly if the manager has underperformed because the performance fees will be paid merely for coming back to index. Is this margin squeeze or marketing skill? The point is: it’s not margin crunch in funds management. It’s the opposite – more fees for the same work.
The other options available to managers today is launching ETMFs which will invest into the main unit trust fund that created the brand name. It’s been happening quite a lot as managers look to reach new clients on a direct basis and in particular via the SMSF channels where advisers are less prevalent.
It’s a natural move for distribution diversification and if it’s done via an LIC it also offers instant revenue for listed fund managers and that keeps their own shareholders happy.
The question on everyone’s lips these days is ‘who is the listed fund manager working for?’ Their own shareholders or their new investors? It seems to be becoming very difficult to align interests.
For example, an LIC may have a performance bonus for portfolio management but if the LIC headstock underperforms the NTA in the longer term, then LIC shareholders are paying bonuses without evidence of performance. It is not an easy thing to re-align because the assumption is the headstock will close the NTA gap through time if the portfolio consistently does well. In real life that doesn’t happen very often as the portfolio will no doubt have its ups and downs.
The reverse of this cynical view was applied when meeting with a manager that believes in their process so much that it is considering the launch of an SMA portfolio that reflects their main unit trust, with no fixed fee but a high-water performance fee. It is only payable after delivery, so investors can’t lose and wouldn’t complain.
This is particularly savvy because an SMA should carry lower structural costs than a unit trust as there is no unit trust registry and lower PDS and all the legal costs attached to a MIS. In summary, the manger is backing itself in its flagship fund and prepared to mimic it for investors wanting an SMA – whereby their own costs are contained and scalable.
In both examples the point is that there are still lots of fees available in funds management. The trick these days is to decide what end of the barbell to sit. An investor can choose active management with a variety of vehicles collecting fees for a single management style (margins may be cut but there are more fees) or he or she can go indexed, use technology and scale and collect lower amounts.
It’s all about choice, which is a much better environment for those that deliver. It’s not about fees. It’s never been about fees. It’s about whether or not there is value in the service.
*Ian Knox is the managing director of Paragem. The views expressed are his own. This article appeared in New Investor on 22nd May 2017. Contact: firstname.lastname@example.org