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When Groupon, an online discount voucher company, floated on the New York Stock Exchange just over a year ago, its directors were betting on consumers’ seemingly unquenchable thirst for a great deal. It was one of the largest web IPOs in history and raised more than $400 million. Barely 14 months later, Groupon’s shares are nearly 80% down on their opening price. Maybe we are not as keen on getting as much bang for our buck as we thought.
This point could also be made for European pension fund investors. In the immediate aftermath of the financial crisis, investors roared at their asset managers—demanding lower fees and “better alignment of interests” between the two partners. Active fund managers saw investors vote with their feet for products perceived as less expensive and passively managed— exchange-traded products hit a record $2 trillion in assets in January, 2013 and BlackRock research showed a doubling of assets in just four years.
Alternative asset managers, who saw huge outflows and investor fear over their non-traditional strategies, fell somewhat into line. Fees paid by asset owners in Europe for these types of investments have been reduced over the past few years, the latest Global Fee Survey by investment consultants Mercer showed in January.
“Clients are very focused on negotiation at the outset,” said Heather Brown, investment partner at consultant and actuaries Lane Clark and Peacock (LCP) and co-author of the firm’s annual survey on fees. “They have fees on their initial plan, but also review fees through the course of the mandate as things quite often change.”
Last year, LCP’s fee survey found some pension funds were able to negotiate up to a 31% discount on new mandates from fund managers and up to 20% off mandates that had already run for some time.
“When pension funds are brought together through M&A or assets grow more quickly than previously thought—especially for defined contribution pensions or when managers are underperforming—clients can and do renegotiate terms,” said Brown.
However, just demanding lower fees has its limits. Fund management and other services cost something to provide, and some investors are taking more innovative approaches to paying for it.
“Cost is really important in a low return environment,” said Henk Radder, director for Investment Strategy & Solutions at Russell Investments in Amsterdam, “and there is a lot of focus on transparency. This includes examining transactions and other costs in an effort to keep these fees low.” Radder added that before the financial crisis, investors had pushed to use performance fees to remunerate achievement by fund managers, but since the crash this method had been used less and less. “If the investment is to be made over a long time horizon, there is likely to be a series of complex ‘floors’ to negotiate for performance fees to be calculated. That is before the whole discussion about bonuses is taken into account,” he said.
Chetan Ghosh, CIO at the Centrica Combined Common Investment Fund in the UK, said performance fees were often so skewed in the favor of the asset manager that it ended up being poor value for the investor. “We have introduced high watermarks and payments are spread out over three to five years,” said Ghosh. “That way we have a system of clawing something back should performance fall away. Managers have been generally responsive to the system.”
Also, outperforming an arbitrary benchmark is all very well, but meeting investors’ liabilities—not just beating the market average—is what counts. “One of the most interesting approaches I have seen is a ‘balanced scorecard,’ ” said Radder. “The investor takes multiple factors—solvency, performance, how the manager reported to the client—before making an in-depth evaluation and basing remuneration on that.”
Rewards can be based on the particular investor’s goals: remuneration for global equities might be based on a risk-adjusted return basis and the client may even specify its own measure of risk, for example. Some investors—and asset managers—may not appreciate the level of subjectivity in this system, however.
It is the fiduciary duty of the person in charge of investment activity to get the best possible deal on fees for the fund, but that does not just mean getting the lowest charge. Some managers are expensive for a reason, and others are cheap for the same.
Read the related cover story–“Who’s Paying What?–here.