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May 25th, 2021
By Benjamin Olmstead
The challenge of understanding list vs. actual fees in active management.
What asset managers actually charge for mandates varies from list rates. One main reason for the disparity is timing. Actively managed fees have been declining for years. Asset manager list rates may not vary much over time, while actual paid fees fluctuate to meet market conditions.
Fee discounting is particularly prevalent in actively-managed investment products. Continued discounting without transparency into actual paid fees can have significant impacts on margins and relationships as the industry increases its focus on active strategies.
While reaching fee alignment and gaining pricing efficiency is the ultimate goal for all participants, asset owners, investment consultants, and asset managers, the challenge is acquiring the reliable fee data needed to achieve fee transparency.
List vs. Actual Fees
Using fee data from live portfolios extracted from Investment Metrics’ Portfolio Analytics and Reporting solution, the chart below illustrates discrepancies in list and actual fees.
US Core Fixed Income is listed at 26.9 basis points (bps) for the 0-$50M mandate size while actual transactions were at 23.7 bps over the prior year, an 11% reduction. All figures are based on institutional separate account or commingled fees. Another asset class, non-US Large Cap Equity, is listed at 69.2 bps for 0-$50M while it has sold at 67.9 bps in the prior year, a 5% reduction.
However, the variability of the asset classes tells a different story. US Core Fixed Income sold for 10.0 to 52.4 bps at the 0-$50M size in the prior year, while Non-US “International” Large Cap Equity ranged from 50.0 to 94.2 bps at 0-$50M.
Aligning Pricing Mandates
Knowing the average transaction discount will work if you are generating average returns. If you are outperforming or managing lower than average volatility in the highly volatile COVID era, it is key to understand the specific attributes that go into pricing any mandate. You never want to leave money on the table. At the same time, you also never want to be perceived as taking advantage of the plan or the consultant.
Game theory suggests that two economic agents with different preferences for outcomes can come to a mutually beneficial solution. In a nutshell, this means asset managers want the mandate at the highest price, while asset owners and consultants want to award the mandate at the lowest feasible price. There is an optimum price where both sides will feel good about the transaction. After all, both sides want to reach fee alignment and gain pricing efficiency.
Key Price Drivers
The million-dollar question is, what should that price be? Price is dictated by many factors including size of mandate, type of client, performance, and range of peer returns.
The following chart, using Investment Metrics data, highlights one style, plan type, across 926 observations in non-US International Large Cap Equity. It examines only the most recent data, prior year only, which is why a few categories are missing. We found no mandates greater than $300M in the Endowments and Foundations universe in the prior year.
The chart also highlights how Corporate Defined Benefit (DB) plans paid the highest fees for new accounts in the prior year. Public DB plans also purchased a lot of International Large Cap Equity. The type of account is one aspect that should be considered when pricing a strategy.
US Core Fixed Income tells a slightly different story in the chart below. Products priced above the universe median have garnered the most assets in the prior year. Most outperformed on a 1-year basis and the majority also outperformed on a 3-year basis. While fees are in a tight band slightly above the universe median and averages in the low- to mid-20s, there are a number at 35 bps that were won in 2020. There is opportunity, especially in the Taft-Hartley area. That plan type placed the largest number of mandates in 2020 by number.
The Value of Fee Benchmarking
Understanding the discount rate is important. However, understanding how your strategy stacks up to competitors on actual fees and in the context of variable performance and risk will allow asset managers to win assets while being competitively priced. Game theory is clear that different preferences for outcomes dictate negotiations, but there is a point where both parties can be satisfied. Starting with all the information, including actual recent transaction prices, will help asset managers achieve a fair, competitive and mutually agreeable price.
The Importance of Reliable Fee Data
Having access to actual post-negotiated fee data – rather than stated fees common in traditional fee databases – empowers asset managers, asset owners, and investment consultants to analyze actual fees for custom mandate size ranges across all plan types. Armed with reliable fee data, asset managers can gain the competitive insights they need to drive contract negotiation, price new products, and properly align fees against the market.
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