Watson Wyatt has indicated it will make better use of its group buying power in fee negotiations with managers.

The consultant dissected the potential for “;extravagant fees and extravagant salaries”; to erode investment returns for super funds at its latest Ideas Exchange meeting with managers. Graeme Miller, Australian head of investment consulting, said that hyper-competition had led to significant imbalances in supply and demand in the industry. “The competition is having an adverse impact and increasing the hurdle over which (investors have to) jump. It is increasingly difficult to find value,” he said. The weight of money in the system was fuelling the pressure. “It’s led to higher asset prices, extravagant fees and extravagant salaries,” Miller said. “There’s a winner’s curse in that as soon as something does succeed, money piles in and the returns get priced away.” He said that managers were evolving more quickly than their clients. Fund governance was not changing quickly enough. There was a “governance gap”. By this Watson Wyatt means that for a fund to take advantage of the investment innovations of the last few years, it needs a governance system which includes delegation of authority to a significant in-house team and the use of specialist advisers. A recent report by Watson Wyatt showed that the best-performing funds in the world tended to spend more than twice as much on in-house costs (mainly staff) as the average fund. Each of the speakers at the meeting, in Sydney last week, mentioned fees. Craig Baker, global head of manager research for Watson Wyatt, said: “We think fees are a big problem.” He gave an example of what he said was a common fee structure for long short equity funds, which was a base fee of 1.5 per cent and performance fee of 20 per cent over no hurdle. In the example he gave, which was a fund with a significant net long bias, if such a product delivered 7.5 per cent alpha for every 100 per cent gross exposure, under that fee structure the manager would get half of it and the client half. If the product delivered 5 per cent alpha, the manager would get 65 per cent of the alpha and the client 35 per cent. If the product delivered 3 per cent alpha, the manager would get all of it. “We think there are some very bad performance fee structures… But this will change. The reason that managers have gotten away with it is that the beta has been so good so that the net returns still look attractive on an absolute basis. If market returns are lower in the coming years then it will become clearer that alpha is the key driver and you (managers) will have pressure where fee structures are badly designed.” Answering a question from the floor, Baker said that historically Watson Wyatt had probably done too much of its fee negotiating on a client-by-client basis. With a significant level of assets under advice for funds around the world, Baker said “if anyone has the opportunity to change the industry for the better it is probably us”. Miller added: “We have no problem paying high fees for great managers. You need to price your business on capacity too.” Jignasa Patel, head of equity research in Australia, said the main issues for managers were “people turnover, capacity and fees”. The people turnover among managers in Australia was unprecedented and probably greater than anywhere else in the world. There was an increasing number of newer teams with unproven working relationships. About half of all equity teams in Australia had less than five years experience together and a third had less than three years. “So, firms are changing their structure in order to retain talent. There’s also a focus on softer issues such as work/life balance, providing intellectual challenges and freeing people from bureaucracy.”

Leave a comment