Frontier Advisors has said fund managers fees can come down by 25 basis points over the next five years, advocating a move away from an ad valorem fee structure to a flat dollar fee with a CPI escalator, combined with a performance fee that genuinely rewards true skill.
The current norm for fund managers’ fee structures means that fees have grown in line with AUM. One major publicly listed fund manager’s AUM has increased by 1,347 per cent with a corresponding rise in base management fees of 1,522 per cent from 2004 to 2014, while another’s base management fees have increased by 628 per cent and AUM by 740 per cent.
This is despite the fact the cost of managing money does not follow a one-to-one relationship.
According to Leigh Gavin, senior consultant at Frontier Advisors, the cost of managing $1 billion is not very different to managing $10 billion in most asset classes, and certainly not different enough to warrant the use of an ad valorem fee model with little or no acknowledgement of scale, and so the increase in fees has resulted in significant leakage from the system to managers.
While adamant for the need for fund managers to prove their “value for money” he was pragmatic and said this would be a gradual process, offering the idea that by growing managers fees by CPI (assuming growth of 3 per cent per annum) and assuming super funds grow by 10 per cent per annum, the average industry fund MER could be pared back from 0.78 per cent to 0.53 per cent over five years. Managers would still experience growth in dollar terms and be able to run sustainable businesses as the system continues to expand, super funds would maintain a diversified portfolio, while scale would begin to accrue to members through the reduction in fees.
Frontier Advisors maintain that fund managers provide benefits to super funds’ returns, through both unlisted and listed assets, but say this not an excuse for fund managers to avoid a value for money assessment. Research undertaken by the consultant, which represents more than a quarter of super funds by assets under advice in Australia, also shows there is no clear link between investment fees and performance.
Presently fund managers exploit an economic concept termed ‘economic rent’, which operates on the principle that agents in the system can only earn economic rent if they have a perceived scarce skill. In the case of managers there is a perceived shortage of skill in generating alpha, allowing them to charge over and above the amount that would be charged in a normal, competitive industry.
This is compounded by the use of an ad valorem fee structure, which is based on taking a percentage amount of funds under management instead of a fixed dollar-based contract – an almost unique pricing structure for the provision of a skill.
The closest industry structure Gavin could find in a wide search for a comparison was the salaries of soccer players in the English Premier League. These have increased by 1,508 per cent since 1992 while average wages in the UK have increased by 186 per cent over the same period, according to the Guardian.
Gavin encouraged managers to be innovative in their fee proposals to superannuation funds, noting that the increasing interest by superannuation funds in internalisation, disintermediation and substitution ,for example active to passive or smart beta, was essentially a message to the manager community that changes are needed.