Fee Power Dynamics Now Favor Institutions. Just Not in Private Equity.

A Cerulli report says allocators have gained the “upper hand” in fee negotiations for many active strategies — with notable exceptions.

Illustration by II

Illustration by II

For years now, active managers have been under pressure to lower their prices as allocators increasingly seek to negotiate fees — and the bargaining power that these managers bring to negotiations is “dwindling,” according to Cerulli Associates.

Asset owners have been making the “power play” of consolidating the total number of active managers in their portfolios, according to the research provider’s new report on North American institutional markets. Per the report, a lower active manager count simplifies manager oversight needs and helps ensure that active bets aren’t diversified away. It has also given allocators more leverage with prospective managers.

“Institutions have gained the upper hand in fee negotiation,” James Tamposi, senior analyst at Cerulli, said in a statement. “By re-directing their portfolios to fewer active managers and, hence, making larger allocations, institutions are securing better rack rates and leveraging bargaining power in the fee negotiations.”

This change in power dynamics continues a shift that began when institutions started allocating more money to passive strategies. In a report earlier this year, Cerulli noted that asset managers were most likely to capitulate on fees in asset classes where investors could easily go passive.

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“In the face of price competition and dwindling bargaining power, asset managers are evaluating their existing systems for fee negotiation,” Cerulli said. Managers surveyed by the research firm “cite the cumbersome process of fee negotiation as a burden,” and are looking to streamline this process by “reducing the number of discounting decisions that reach the top echelon of business decision-makers,” the report stated.

Other factors for active managers to consider, according to Cerulli, are any potential non-investment services that clients require, the size of the mandate in question, the demand for and capacity of the strategy, and the existence of most-favored nation clauses, which guarantee the best terms to certain clients.

Capacity-constrained strategies, for instance, are “relatively insulated from pricing pressure,” according to Cerulli. In addition, the research firm said allocators are willing to spend more on “esoteric products that are more apt to attract excess returns.”

For these reasons, Cerulli found that the upper hand gained by allocators in the public markets has not necessarily extended to private investment strategies, which have suffered the least amount of fee compression.

“Top-tier private equity manages are increasingly difficult to hire — a large dispersion of returns in the space has enabled top players to raise funds quickly while investors compete to secure allocations,” Tamposi said in the statement. “These managers can command a higher fee and consumer an increasingly large portions of institutions’ risk budgets.”