As institutional investors increasingly focus on keeping costs low, asset managers are having to perform a balancing act on fees: Go too high, and miss out on otherwise lucrative mandates. Go too low, and leave money on the table.
In a new report on asset management fees, research firm Greenwich Associates suggested that mispricing could be “fatal” to a manager’s business. Although fees ranked low on investors’ manager selection criteria as recently as 2013, Greenwich said that fees are now often “the first and, in some ways, the most important factor considered by institutional investors in a manager search.”
“Today, most manager searches start with fees,” the report stated. “Only after screening the universe of managers for fees do many institutional investors start evaluating the relative merits of competitors on other counts.”
And the focus on fees doesn’t stop with this initial screen. Greenwich said allocators “are looking for discounted rates in RFPs and expect further negotiation on fee levels throughout the process.”
According to the report, a majority of all allocator types — public and corporate pensions, endowments and foundations, and multi-employer plans —negotiate fees with their managers at least “sometimes.” Public pensions were the most likely to negotiate on costs, with 24 percent negotiating “frequently” and 8 percent negotiating “always.”
To provide an indication of how much asset managers stand to lose from over- or under-charging prospective clients, Greenwich offered the example of a firm with $5 billion in annual inflows and average all-in fees of 50 basis points. Losing just 5 percent of mandates due to overpricing could cost a firm of this description $10 million in revenues, according to the report. Undercharging by 10 basis points on 5 percent of mandates, meanwhile, would cause them to miss out on $2 million.
“The negative impact on margins could be even more significant over the life of the mandates,” the report stated.
There are some exceptions: Greenwich reported that managers in some alternative asset classes have been able to not just keep fees from falling, but increase pricing. The research firm’s fee database also shows that managers who experienced top-quartile performance the prior year are able to charge a premium — though that benefit did not extend to managers that outperformed over longer timeframes.
“Managers with strong three- and five-year track records would be at risk of pricing themselves out of business, while managers with strong recent performance might be too cautious about increasing fees, leaving money on the table,” Greenwich managing director Andrew McCollum said in a statement.
But “for most of the industry, fee compression is a reality that must be addressed,” the report stated.
This includes the growing defined contribution market, according to separate research from Cerulli Associates. The asset management research firm reported that fee compression in target-date funds, a popular option in 401(k) plans, has persisted “unabated” as cheaper, passive versions of these funds have gained ground.
According to Cerulli, there are still more assets invested in active target-date funds compared to passive versions — but the gap is shrinking. In 2018, active funds had a 12 percent market share lead over passive funds, down from 18.1 percent in 2017.