Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
How internalisation is changing the costs conversation
Super funds’ penchant for driving down external manager fees is nigh on legendary, but investment internalisation has saddled them with a plethora of new costs that can nibble away at the discounts they want to pass on to members.
“They used to pay an external manager x basis points and get a performance track record and try and drive them lower on the fees,” Duncan Higgs, bfinance managing director and head of portfolio solutions, tells ISN. “Now they’ve made this big step of internalising everything, saving the management fee but paying a bunch of other people and effectively setting themselves up as an asset manager. Are they as good a transactor as an external manager?”
“Explicit costs of trading get reported – things like brokerage costs, fees, and taxes. But are people making allowances for implicit costs, like whether they’re trading at the right point during the day? Am I selling in the right manner? Am I pinning all my sales at end of day, rather than averaging them through the day, to get a better cost?”
It’s a project that will require a more granular focus from big super funds, especially very large merged entities that have already brought significant chunks of asset management in-house and are now looking beyond liquid equities and fixed income.
“We see it as a kind of natural progression to the very basic stuff, like manager fees, where you just hit managers over the head a bit; you talk about value for money and how they trade and all the other stuff that comes with it,” Higgs says. “We’re trying to add more dimensions to just looking at it as a pure good or bad management fee.”
And while size is a boon for driving fee discounts, Higgs says that being of very large size – and so able to dispense hundreds of millions or billions of dollars in a single mandate – only gets you so far.
“We see it across all markets; it’s not just about the asset base or putting blocks together to make bigger blocks because you wind up with a completely different set of challenges,” Higgs says. “The bigger your mandate size the more likely you are to get a fee discount, but if you’re in there with $100 million you’ll get as good a discount as $500 million. It doesn’t seem to play out that having loads and loads of money behind your discussion drives that down.”
Locally, Higgs says, funds are worrying about the unintended consequences of a regulatory agenda that has them pinching every penny with an eye to member outcomes.
“I think it’s about clarity and transparency for a lot of the funds still; they’re being asked to report in a certain way and drive down fees as much as they can. Is that at the expense of value for money, performance and member experience?” Higgs says. “That’s the measure of success in fees and costs; there’s a number in the report that they have to give out, but does it give you that measure of success you want from your fund?”
