Mispricing Fees ‘Can Be Fatal’ for Asset Managers’ Business

Mispricing fees can be “fatal to a manager’s business,” according to financial consultant Greenwich Associates, which said asset managers can lose millions of dollars in revenue by either overpricing or underpricing fees.

“Fee compression is one of the biggest challenges facing institutional asset managers today,” said Greenwich Associates in a report. “Institutional investors are focused on fees to a level never before seen in the industry.”

The report said that until recently mandate pricing was “almost an afterthought” but that manager searches now start with fee screening that immediately eliminates from consideration any manager with list prices that aren’t acceptable.

“The art of determining fee levels, schedules and structures has become an increasingly important part of the asset management business,” said the report, which added that many managers put themselves at a competitive disadvantage by setting fees without having access to benchmark data that shows the idiosyncrasies that influence pricing of institutional mandates.

“Managers that rely on top-line industry averages to benchmark fees – or worse, the‘in-depth knowledge’ of their salespeople – risk mispricing to the upside or downside,” said the report. “This can result in millions of dollars in lost revenue and reduced profits – potentially fatal errors in today’s hypercompetitive marketplace.”

Greenwich cited several reasons institutional investors are now paying more attention to fees, including reduced return expectations. The report said that fees are generally not a big concern when investors are seeing strong returns, and are confident those returns will continue.

But in today’s market of slowing growth, rock-bottom and even negative yields, and lowered return expectations, every basis point counts

Fiduciary responsibility is another reason pricing has become more important to institutional investors, according to the report. Technology has made markets and asset managers more transparent, and that means fee arrangements between institutional investors and asset managers are now much more likely to become public.

“Faced with the very real prospect of shareholder lawsuits and negative media coverage,” said the report, “institutional investors are taking the notion of fiduciary responsibility seriously and are actively working to keep fees as low as possible.”

The report pointed to the Pennsylvania Public School Employees’ Retirement System, which passed a resolution last year to lower fees paid to its managers by $2.5 billion over the next 30 years by renegotiating existing fees and managing more assets internally.

Greenwich also cited “active underperformance” as another reason investors are putting a higher priority on fees. “Unfortunately, many active managers are coming to the negotiation table with a disappointing track record of investment performance relative to benchmarks,” said the report. “That gives even more leverage to institutional investors.”

Additionally, the report said institutional investors are shifting from traditional portfolio construction to models using more index or passive strategies. “Lower demand for active strategies mean lower fees for many active managers,” said the report.

It is for these reasons that “in the current environment, mispricing can be fatal to a manager’s business,” said the report. For example, an asset manager with annual inflows of $5 billion and average all-in fees of 50 basis points, losing just 5% of mandates due to overpricing would represent a loss of $10 million in revenues. At the same time, underpricing 5% of mandates, by 10 basis points, would equate to $2 million in lost revenue. And the negative impact on margins could be even more significant over the life of the mandates.

“At a time when fees are playing such a huge role in institutional investor decision-making, managers cannot afford to be out of step with the marketplace,” said the report. “It’s becoming even more complicated for managers and institutional investors alike, as the industry experiments with new approaches intended to better align asset management fees with client outcomes.”