Proving managers' worth
IPE asked three pension funds – in the Netherlands, Austria and Sweden – the same question: ‘What do you see as the evolution of fee structures?’ Here are their answers:
Richard Grottheim, executive vice-presidnet and CIO of the Seventh Swedish National Pension Fund (AP7) which has assets under management of SEK65bn (e7bn)
“Fees are always an important factor, and AP7 is a defined contribution plan so from our point of view they are more important than for others because we have to survive on an income of 15bps. As a result we are generally very tough in negotiations.
“This may be in contrast to the other AP funds, for example, which do not have an explicit target for how much they can spend and so there was a recent debate on whether they were spending money efficiently, especially for investments in hedge fund and other very costly instruments.
“Of course as we grow and have more assets under management we get additional income and with more assets we can negotiate better prices.
“We outsource a lot – approximately 80% of our assets while 20% are managed internally. The only things we do internally are Swedish index-linked bonds and active Swedish equity. The major external element is a passive mandate, for example we are purely passive in the US, half of it in Europe and part of in Sweden. Then we have a large active mandate in Japan, two in Europe and a small one in Sweden.
“Fees in Sweden on actively mandates are generally quite low from on a global perspective. While I don’t think they can fall further, they are certainly not going up.
“And in the hedge fund world we see a very clear downward trend on fees, and I think is good, but they are very costly.
“We have also seen a similar tendency in private equity. The clear development was for a downward trend when the public market equity managers had their bad years during the market fall in 2000, 2001 and 2002 but hedge funds because they were very popular in that period saw stability around their fees.
“But then the public market picked up again and the downward trend in the public equity managers’ fees has not been as clear as before. And when the hedge funds then had problems, mainly in delivering performance, this was reflected in pressure on their fees.
“Over this period hedge funds have gone some way to becoming a mainstream rather than alternative asset class and in general the substantial returns of their early days have moderated.
“However, the managers who have been able to sustain their exceptional performance are tougher on fees. And you could also ask whether they should be so expensive because there is another per cent added onto the 2 & 20.
“But for an organisation like us with limited resources are they worth it? Well, without such managers we could not have entered hedge funds and private equity funds of funds. And all the assumptions we make in the asset allocation studies on expected returns include fees. So as long as they can deliver the agreed performance they are worth it.”
Paul van Gent, fund manager at PME, the Dutch industry-wide Metalektro fund, which has AUM of e19bn.
“We had traditional mandates five-to-10 years ago with fixed fees that could generate 1.5-2.0% of excess return for which you paid 30-50bps, so the profitshare going to the manager was in the 15-25% range.
“But looking at a report on the highest hedge fund earner taking 5% fixed plus 49% of the profits, and looking at hedge funds that might generate a 10% return taking 2 & 20, that’s 40% of the return, suggests we are talking about fee levels that are unsustainable.
“Each player in the industry will claim to be unique and that the market he is going for is limited and so you have to pay for access to the short supply of good ideas. But you have to ask whether this level of fees isn’t extreme and whether they are worth it? Especially where the fixed component is paid whether they have skill or not, so you’re out of pocket whatever the base fee is.
“But we can look at fees from a different perspective. Were I 100% certain of the skill of a manager I would want to hire him on a fixed-fee basis because I’d probably end up paying less. But the more unsure I am about his performance or the higher the fee I am asked to pay the more I’d like him to share in the upside because it helps mitigate my risk.
“Of course some markets make higher returns than others but I baulk at such a high level of fees and we will not pay them. I think you can find good people offering a valuable product for reasonable fees, at fee levels around 15-20% of the added value.
“Furthermore, we also wonder why the fee has to be based on the asset under management when often the skill you’re asking for is the same as with a lawyer – there’s a trick and you want access it, and you could buy it at an hourly rate.
If there’s scarcity of assets, then paying an asset-based fee may not be strange, but it should not be the case for assets for which there is no scarcity.
“If you have sufficient assets you can do a large portion in-house and still end up with very good investment results, which is another way of having access to skill in a fixed-fee way, through hiring personnel.
“We often go for a combination of fixed and variable. We take the view that a manager needs certain amount of fixed income to keep the lights burning, but for that you’re talking passive management-type fees. Beyond that you’re talking profit share but he should also put his risk on the table. And it should be a profit share with a hurdle. No-one should be sharing in profit until the basic beta in the asset is earned back. Then we can see what the real value added is, because the added value portion is what we should be paying the variable fee for not what is the risk-free portion, or at least the beta portion of it.
“And in the performance-related fee area we have the issue of ‘optionality’, in that if a manager gets a performance-related fee on each year’s result he has an option. So if on average I have lost money because he made money in the good years and lost it in the bad years and on average it ended up on zero, I will have still paid him a performance fee for some years. Although the introduction of high-water marks, clawbacks and smoothing addresses this to a certain extent it is not always fair and that the manager has also given himself a free option to still earn a lot even if he has not performed on the whole.
“And the introduction of high base fees means the manager can be sure to get 2%, and he has €1bn in assets under management he’s not going to go hungry, even if he got zero on average.
“That to me is not a good way. What we want to pay for is structural high performance and not incidental performance.
“In addition, many managers are also adding in lots of costs that should be in the fee. It’s quite a complex process to find out what are fees and what are costs, so probably the figures that are usually quoted are even worse in reality.”
Michaela Attermeyer, responsible for asset management with VBV-Pensionskasse, which has AUM of e3.8bn
“We outsource the larger part of our investments, about 90% of our assets are externally managed. What we have done in the last few years in, for example, our global equity mandates, is to switch from a fixed management fee, which was rather high, to a performance-related arrangement that includes a lower fixed fee and an out-performance target.
“And as an Austrian pension fund, eurobonds are very important for us and here fees are coming down. Perhaps this has to do with our strategy where we rather prefer mandates that are closer to the index.
“On bonds in general Austria is a little different from some other European countries because from the legal point of view we have a fixed discount rate and not a market rate for discounting liabilities.
“When it comes to specialist areas we have to differentiate between two sorts of products. We have, for instance, a hedge fund of funds which is a segregated fund exclusive to VBV Pensionskasse. And here we think the fees are acceptable.
“But where these products are available to a wider public the fees are very high. If we have no possibility to negotiate fees it is a problem for us.
“However, I think that VBV-Pensionskasse is large enough to be able to diversify. We have different portfolios but nearly all use the same products, although with different weightings. So with the hedge fund of funds in one portfolio the weight will be, for example, 2% and in another 5%, but the product is the same for all the portfolios. And in such cases we aggregate them together to negotiate a better fee.
“And although we have not done any new investments in hedge funds these last few months, I can imagine that the very high performances they had are some years ago are not being replicated and therefore fees could be falling.”