Institutional investors, facing both lower returns over the next decade and growing liabilities, are taking control of the one factor they can: costs.
A recent survey of 89 participants from 86 large money managers found that asset managers are increasingly discounting fees in the face of pressure from big institutional investors. According to the survey, conducted by Institutional Investor Membership groups, 21 percent of respondents reported that discounting had pushed fees down by up to 20 percent. Another 23 percent said fees declined 20 to 40 percent.
The asset management industry is among the most profitable in the world, but fee pressure combined with lower market returns from investments could significantly drive down margins. Asset managers are also being hit by the growing use of cheaper and commoditized passive strategies that simply aim to match the performance of an index. In a paper in the Financial Analysts Journal last year entitled “Murder on the Orient Express: the Mystery of Underperformance,” Charles Ellis writes, “over the past several decades, fees for institutional investors have risen from less than 1/10 of 1 percent to nearly 1/2 of 1 percent of assets for equity investments (less for fixed income and more for such ‘alternatives’ as private equity and hedge funds).”
Institutional investors are throwing their weight around, but it helps to have more weight. Sixty-four percent of managers in the U.S. and Europe said the size of the mandate was the most important factor in determining whether they would lower fees. In recent years large institutional investors, including the $117 billion Teacher Retirement System of Texas, have entered into so-called strategic partnerships with traditional and alternative asset managers. These relationships redefine the contract with asset managers, giving them broad latitude over investment decisions but also giving investors a big break on fees.
In a survey finding that might put the most pressure on asset management fees, investors are increasingly demanding “most-favored-nation” clauses in their contracts. Under these arrangements, managers agree the fees charged to a client are not higher than those that other clients with similar mandates are paying. Three quarters of respondents said they offered these deals when investors requested them.
Of course, not all managers are yielding to their clients; 53 percent of managers say performance fees, increasingly popular with institutions, have remained steady in the last year. A study last year from State Street Corp.’s Center for Applied Research found that institutional investors are allocating more to alternatives, such as high-cost hedge funds, private equity and other illiquid investments.
Patrick Keenan, who recently started Oak Advisory, a consultancy to advise Taft-Hartley accounts, says managers should be able to easily lower fees, given that much of their research and other services are spread among many clients. “They do research once. Does everybody have to pay for that?” He adds, “the downward pressure will continue as more people become sensitive to fees and their responsibility to manage those dollars as well as they can.”
