Most pension funds are paying less than sticker price for fixed income managers.
Between negotiating lower fees for larger mandates and discounts for long-term relationships, actual fees paid by investors can be up to seven basis points lower than what fixed income managers say they charge.
“You expect there to be some wiggle room for negotiating fees,” said Peter Laurelli, global head of research at Nasdaq’s eVestment, by phone Monday. “It was interesting to see how the difference between stated and negotiated fees changed based on whether it was a more complex investment strategy.”
Laurelli and his team at Nasdaq eVestment partnered with Mercer to collect data on the stated management fees of 2,129 separate accounts in fixed income strategies, as well as nearly 200 examples of actual fees paid, aggregated both from documents sourced by Nasdaq eVestment and Mercer’s own data.
The data shows that funds posting top-quartile three-year performance (through the first quarter of 2022) generally charge a premium compared to their bottom-quartile peers. The difference between top- and bottom-quartile fees is most pronounced in global unconstrained fixed income strategies, with a 7 basis-point spread.
Case studies included in the eVestment report revealed a few things. First, in two separate high-yield investments, pension funds with long relationships — one dating back to 2005 — and large check sizes kept fees well below market rate.
“In the U.S. core segment, there was a pretty consistent reduction in fee values and actual fee values as mandate size went up,” Laurelli said. The data shows that stated median fees for core fixed income strategies start at 0.3 percent for $25 million allocations. They come down to 0.21 percent for $500 million plus allocations.
Actual fees paid by investors in those categories were negotiated lower, though. For $25 million allocations, median fees were actually 25 basis points, while for $500 million allocations, fees were 14 basis points, the data showed.
There is less wiggle room, though, in a strategy like emerging market fixed income. Stated median fees for emerging markets hard currency strategies were 0.5 percent for $25 million allocations, and 0.42 percent for $500 million allocations.
Actual median fees paid on $25 million allocations to the strategy were 0.42 percent, while for $500 million allocations, fees were 0.39 percent. In other words, for the largest allocations, there was just a 3-basis point reduction in stated versus actual fees.
“The ability to negotiate within these more specialized strategies is a little more difficult,” Laurelli said.
However, there are exceptions. Two emerging market strategies with lower-than-market-rate fees were added to pension portfolios in 2020. According to the report, Covid-driven uncertainty allowed these investors to negotiate lower cost structures.
Meanwhile, pension funds paying higher-than-stated fees in two separate unconstrained strategies were shown to have invested less than half of the minimum separate account requirements.
“I thought it was interesting that in different categories, managers will accept smaller than what they state as a minimum investment, but it’ll cost asset owners a premium to access that,” Laurelli said.
In another case, it appeared that a pension fund was not aware that its manager had updated fee terms to be more favorable to limited partners — and thus was being overcharged. While Laurelli noted that this was an uncommon situation, the pension fund was not alone in being overcharged.
“When you enter the negotiation process, having that information is critical,” Laurelli said.
That is especially true now, as the bear market, rising inflation, and increasing interest rates have prompted investors to reconsider which fixed income strategies they use.
According to data shared by Nasdaq eVestment, U.S. long duration credit, Treasury STRIPS, and U.S. stable value fixed income have seen a high amount of inflows during the first and second quarter of this year.
Meanwhile, U.S. core-plus fixed income, global multi-sector fixed income, U.S. corporate fixed Income, and U.S. high-yield fixed income are seeing the reverse. Given the flow of capital, investors in either category may see opportunities to renegotiate fees with managers.
“Anytime there is a movement of assets across a category, that may result in new relationships and mandates for some managers, which is when fee negotiations are key,” Laurelli said. “Then also holding onto mandates: Negotiating fees can make a difference in whether you lose completely or maintain part of the mandate.”