Michael Gordon* puts the fund management fee debate in perspective.
Much has been written on these pages in recent weeks on the issue of fund manager fees. The argument is not new and is typically partisan. However, in 30 years in the business I’ve never seen fee pressure so extreme.
Fees right across the traditional asset management agency chain have been slowly eroding for years but that orderly slide has accelerated in the last couple of years with fees “gapping’ lower in renegotiations or from those pitching for new business. Why is it so, is it a problem and, if so, what should be done?
From the perspective of the superannuation fund member, the costs of agency across the fund management chain go well beyond the fund manager. This begins with costs of the staff at the fund itself and continues through to the fund manager(s), the consultant, the custodian and of course the fees the fund manager pays to brokers and banks for research. These latter fees don’t get disclosed too often though offshore regulators are now on the case – watch this space! Over the years, pressure has come onto all agents in the chain. It’s been most acute at the consulting end where pure asset consulting would no longer appear a viable business model. Neither is traditional institutional stockbroking.
Traditional fund managers have seen fees drift downwards whilst also witnessing two trends, both above and below them. Above have been hedge funds and alternative managers who began their journey at “2+20” and whilst those numbers have come down, still enjoy a healthy premium. Below are the disrupters which are passive management and quantitative strategies.
Superannuation funds and asset owners are both entitled and right to think about costs. The argument that they are purely driven by fees for their sake alone would seem to me to be mistaken. The growth in the AUM of the largest funds in the country, behoves them to consider the benefits their scale brings them. The ability to seek economies of scale is but one. Fund managers may cry but it is they who have been crushing their brokers’ fees for years. The local fund management industry may have a few staff on the street at present but its nothing when compared to the reduction in the ranks of brokers, particularly in the area of research. Fund managers are also very harsh on any company they invest in who don’t manage costs efficiently.
In thinking about the business of fund management then, as in any business, there are three main stakeholders to consider – the owners, the staff and the clients.
In their letter to this publication [Investor Strategy News], Damian Maloney and Fiona Trafford-Walker of Frontier Advisers considered the owner’s perspective and looked at the economics of Franklin Resources. They judged it to be healthy, with margins that many other industries would envy. That is largely the result of a historical book of business though. The share prices of asset managers are a better reflection of what is going on.
Over the last 12 months, leading traditional or more ‘core’ type asset managers have seen their share prices drift lower, underperforming more broader stock market indices, breaking with a more traditional and symbiotic pattern of positive correlation. Franklin Resources, Henderson and Invesco are three examples. This means, those with capital to invest are preferring to put their money elsewhere, for now at least. On the flip side, despite some difficult press Blackrock’s share price has risen alongside the S&P500. Locally, Goldman Sachs, traditionally a ruthless allocator of capital, has recently voted with their feet in their judgement on the merits of the Australian marketplace. Other, generally more specialist managers just don’t ply their trade here.
Frontier correctly points out that an asset manager should manage its margin, amongst other things of course. However, this is inherently difficult when the investment staff, who are generally the highest cost part of the business are so critical to it. There is many a CEO who would like to consider portfolio manager staff cuts in looking to reduce the costs of their business but this puts at risk the very clients who demand lower fees as they would likely remove their mandates and a dangerous spiral would beckon. The CEO can consider cutting portfolio manager compensation but the very best fund managers are all free agents when it comes down to it and if pushed too hard more would work for themselves, happily managing just a fraction of the assets they currently do.
Fund management is a great business and will remain so. As in many other industries we are in an adjustment phase where the shareholder or owner of a fund management business is going to need to embrace lower margins, albeit at still very attractive levels. Whilst historical data is relevant, the margin on new business (in addition to investment performance and flows of course) is going to be a strong guide to the share prices and financial fortunes of businesses in the fund management industry.
* Michael Gordon is a non-executive director and investment committee member of Russell Investments’ Total Risk Management and HK-based FWD Group. He is a former investment manager and executive director of several global funds management firms. Most recently he was group executive of Perpetual Investments and before that global CIO of Fidelity International and BNPP Investment Partners in London. He also sits on the Board of the Australasian Gastro-Intestinal Trials Group.
This article first appeared in Australian industry publication, Investor Strategy News