When Fiona Trafford-Walker, director of consulting at Frontier Advisors, told the AIST ASI conference in September that after years of talking about the possibility of lower fund management fees, funds were starting to make major breakthroughs, there was little fund manager feedback on the speech. Here Franklin Templeton, Schroders, and Vanguard all give their feedback.
Fiona Trafford-Walker’s conviction that change is in the air on fees comes from the renewed focus on costs in response to prospectively lower returns, regulatory pressures on funds, and the growing success some are already achieving in fee negotiations.
The growth of internal teams also means many can assess the value of what they can achieve in-house versus the cost of services offered externally, both for fund management services and consultancy services.
Even funds that are not currently contemplating internal management are being made aware of the costs saved, and this has increased market awareness of the profitability of funds-management firms. In the same session at ASI, Ken Marshman, chairman of REST, indicated that any industry with margins of 40–60 per cent was ripe for disruption.
If that was not enough reason for change, Trafford-Walker says the growth in superannuation funds has also placed the spotlight on the need to capture the benefits of scale from that growth on behalf of the members or plan sponsors.
And she is seeing results. “What I see is concrete action by an increasing number of funds to review costs from every angle, and to put in place plans to bring them down, including internal management, disintermediation and mandate consolidation, and fee negotiations to reap the benefit from scale,” she says, measuring the size of the opportunity as moving the median Australian fund fee of 78 bps to around the 50–60 bps range.
“Some smaller funds that offer something very special that is valued by their members can charge more, but 80 bps for an average superannuation fund is too expensive,” she said.
Trafford-Walker’s message was that funds should approach contract negotiations with fund managers much more on a business basis, with the biggest area for opportunity being in asking for ‘aggressive’ scale discounts. The premise for such negotiations should be the growing size of some allocations of money to managers. She reasons that the marginal cost of investing an extra dollar becomes increasingly lower, and that if managers are not prepared to talk in such terms when setting fees, then superannuation funds need to walk away and find alternative providers.
She also urges funds to get fund managers to retender their services after three years. “It would be a good idea to say ‘It’s a three year contract, if you do a good job it will continue’,” she says. “It’s a good chance to review and possibly reset the business relationship between the fund and the fund manager.”
To maintain momentum, Trafford-Walker advises that it is not merely the investment team that should own this change. It would have to permeate through to the board and the chief executive, and a set of principles should be agreed upon by all these parties to guide the fund in its approach.
She not only urges funds to continue to take an active role in reducing fees, but that fund managers too should reassess their modes of engagement. “There will be fewer but larger funds in the future, with large internal teams all thinking about how to meet their objectives and remain competitive.”
Trafford-Walker adds that funds are mindful of fund management businesses remaining sustainable, but that in some cases there was not a strong culture of cost control. She gave the example of a fund manager that informed her it had cut 20 per cent of its staff in 2009 after a large fall in assets. The manager gave reassurances that none of these staff were directly involved in the fund management process; however, this led to the realisation that clients had been effectively paying for these non-essential staff previously.
Trafford-Walker also reasons that fees remain high due to a mystique around the way fund management services are marketed as something that is in short supply and as something that has the capability to generate excess returns and alpha. This, she says, partly explains why fund management fees for active Australian equities remained high when there were 140 managers to choose from. Surely, she asks, with so much supply there should be greater fee competition.
Lastly, she answers the common objection from global fund management firms that they cannot charge Australian clients less than clients from other regions. “It is just a matter of time before pension funds everywhere start to step up and say ‘we are not going to pay these fees’. You see it in the Netherlands, in the UK, and in Canada already and you are starting to see media on this from some of the large US pension funds,” she says.
The fund manager position
Three fund managers were bold enough to answer Trafford-Walker’s views on fees.
Here is a summary of their responses.
- Funds should seek lower fees, but look at the big picture
Robin Bowerman, principal, market strategy and communications at Vanguard Australia, agrees that not enough advantage of scale had been gained from being a $2 trillion industry. “We do not think it is just about the fund managements space; what is really important is the end-to-end price for the super member, that includes the transaction and the administration fees,” he says. He also emphasised understanding the value of investment management by focusing on returns after tax and fees too.
For Greg Cooper, chief executive of Schroder Investment Management Australia, cutting fees should not come at the expense of member outcomes. “Funds should absolutely be looking to play to things such as scale in driving down fees, but they should also recognise that it is the overall client outcome that should remain the primary driver,” he says. “As an industry we spend far too much time on the minutia of portfolio implementation, while forgetting that valuations of asset classes and our exposures to them have a significantly greater impact on the end result to members than anything else.”
- Fees in Australia are already competitive
Maria Wilton, managing director of Franklin Templeton Australia, says that not only is the Australian market highly sophisticated, but from the perspective of a total effective fee rate it is priced more cheaply than other markets it operates in. This is a view agreed on by Greg Cooper when comparing global fee rates.
- Fee negotiations for scale are nothing new
Index investing is already highly competitive on fees, according to Bowerman, of Vanguard Australia, and renegotiating fees with increased scale is all part of that landscape. “In the indexing space, it is pretty much a commodity investment approach, that part of the investment world is highly competitive,” he says.
To him, such competition was not as fierce among active managers, a point that Wilton of Franklin Templeton Australia strongly refuted. Firstly, she points out that scale discounts were offered in active management, particularly among Australian equity managers. “There is a tremendous amount of fee competition. We would rarely take a published fee rate to clients,” she says.
- A three-year review of fund managers is a bad idea
This idea was seen as likely to promote a greater use of short-termism. Cooper says: “I would strongly counter the idea of ‘retendering’ every three years, as that implies three years is the right time frame for the investment horizon when that is completely counter to the idea that funds need to invest for the longer term – and tenure (or expected tenure) has a strong influence on likely fees.”
This was a point echoed by Wilton, who saw this as counter to the growing trend for partnerships between investors and fund managers and to the development of long-term mandates. “Mandates that are awarded for the long term allow fund managers to do their job as long-term owners. That is where quality will shine through,” she says. She also talked up the value of strategic partnerships, citing the partnership Franklin Templeton has with First State Super. “We share research and we have open conversations about market trends. It is a true two-way strategic partnership that could lead to new products, and it is more sustainable than a short-term relationship.”
Internalisation may not be a panacea
While Investment Magazine has covered many upbeat accounts of the benefits of internalisation, both Cooper and Wilton urged caution.
“If funds are pursuing internalisation on cost grounds alone, then I would suggest that is the wrong focus and likely to end in failure,” says Cooper. “Asset management isn’t easy and success is driven by a combination of factors. Trying to boil it down to one driver alone is not a recipe for success.”