Alpha’s high price tag revealed by survey

Investors are desperate for alpha and are willing to pay much more for asset classes which promise higher returns, such as emerging markets, a recent Mercer Investment Consulting study shows.

Mercer’s latest global study of institutional asset management fees, which analysed 164 traditional and alternative institutional investment strategies, indicates that highest fees were charged in classes where asset managers had the most potential to gain alpha. “We’ve seen a client base with a higher demand for higher alpha,” Simon Eagleton, principal of Mercer Investment Consulting, said. Emering markets were revealed as the most expensive asset class with median fees of 88 bps for a $100 million discrete mandate, down to 40-50 bps for Australian equities, and 25 bps for traditional active fixed income. This demand led investment managers to devise more risky, capacity-constrained strategies. “These kinds of strategies, like higher-conviction strategies, force managers to take bigger positions with a high level of active risk – usually double or triple the weight of the index – so there’s a limit on the amount of assets you could run,” Eagleton said. Such limitations often trigger a boost in management fees. “Managers earn money as a percentage of money under management, and if assets are limited, they’ll charge more fees.” Furthermore, if managers reap alpha, fees can increase again. “You pay the manager to beat the market, and the more they do this, the more their fees increase.” Eagleton said these management skills are necessary when investing in emerging markets. “These skills – to generate alpha in emerging market equities – are rare. In less efficient markets, like emerging equities and smallcap equity, more alpha is available to a skilful manager,” he said.