Home / Thoughts on the ‘perfect storm’ impacting fund managers

(pictured: Keri Pratt)

By Keri Pratt*

Australian asset managers exist in a superannuation ecosystem that is experiencing rapid or accelerated change (the ‘perfect storm’?) as a result of a range of factors and influences.

These trends include:

• Regulatory change (increasing compliance costs, MySuper limitations and narrowed focus and now the Productivity Commission review)
• The arrival of a low-return environment brought on by QE impacts, such as overvaluations almost everywhere
• Disintermediation driven by technological advances and changes to data access, and
• Industry consolidation driven in part by the increased regulatory burden, and the perception of increased competition.

We can’t know what investment returns are going to be in advance so, naturally, funds focus on what they believe they can and should control: fees, encouraged by the regulator and the perception that this is of key importance to super fund members – the majority of whom are disengaged and don’t make any active decisions about their super.

What are the consequences of a focus on fees as the most visible indicator of performance (‘net of fees returns’)? Here are some:

• Within an asset class: a drive to lowest cost (passive) – entirely or in part, which does reduce active share and the ability to beat a benchmark, for better or worse
• At the portfolio level: there may be an impact on optimal asset allocation decisions if fees are the first consideration (fund liquidity requirements of course may also cause a tilt away from private markets investments), plus the need for a smarter approach to DAA if the fund seeks to add return from this source, which is historically quite hard to get right consistently, and
• From a competitive perspective: differentiating from competition becomes tougher. If everyone has a 60:40 asset allocation and predominantly indexed how does anyone choose?

Jeremy Grantham was right. It’s much better to be wrong together than risk being too different. The other issue here is the alpha-versus-beta argument. The quite frequent view that (rare) alpha is worth paying for whilst beta should be cheaply replicated (this goes well beyond passive and encompasses systematic/ factor based approaches). After 10 years with a quant manager I did not think I would see the day again that quant was ‘sexy’.

The fees evolution is evident not just here but elsewhere. It’s not just Australian funds demanding a better deal from hedge fund and PE managers; the US is experiencing change in the hedge fund world through changes to the mutual fund regulations as retail funds managers capitalise on being able to offer hedge fund-like strategies to the huge US retail market (at flat fees and with daily pricing in most cases).

Last week, Bloomberg News reported Steve Eisman had left his successful hedge fund to join Neuberger Berman where he is offering SMAs to investors at a flat 125bps, which is not super cheap but well less than the usual 2 per cent flat plus 25 per cent performance fee. In the end, they will still only sell a lot if he can deliver on performance.

Australia is down the ‘pointy end’ in the fee debate because of the structure of the Australian market. There is a relatively small number of very large and well-informed investors who have made it their business to determine what they believe is the right price for investment management (and who have, as the economists say, ‘reduced information asymmetry’ when engaging with fund managers).

This shouldn’t be surprising. It may be confronting for fund managers to have their motives questioned over the level of their operating margins but technology, innovation and easy access to information provide even individual investors today with access to cheap ways to access large parts of listed markets, such as ETFs and other exchange-listed vehicles.

The fund manager guys and girls with a really compelling investment case are still winning investors but many other managers have not fully appreciated that their business model may be under threat. It happened first in investment banking but it’s now having a wider impact.

In the end, is this good for the humble super fund member? My guess is that most of them just expect their fund (and fund managers) to do better than the cash rate. The rest is just noise.

*Keri Pratt is the former head of institutional sales at Franklin Templeton and head of client service at GMO Australia. Her position at Frankllin Templeton, along with that of her direct report, James Savage, was made redundant in a cost-cutting exercise early this month.

NOTE: This contribution was prompted by two previous articles published in Investor Strategy News. They are at:

http://ioandcdevelopment.flywheelsites.com/the-ramifications-of-a-relentless-focus-on-costs-and-fees/

http://ioandcdevelopment.flywheelsites.com/frontier-responds-on-whether-fee-pressure-gone-too-far/

Investor Strategy News welcomes further comment on this ongoing debate.