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Special Report

Impact investing


Special Report: Fees & Costs - Light in the fog?

A Europe-wide discussion on asset management fees and costs is heating up. Some regulatory and industry initiatives are proving successful at providing common disclosure frameworks for pension funds and their asset managers, finds Carlo Svaluto Moreolo 

At a glance

• Local regulators are implementing or studying cost-disclosure frameworks.
• Investors are becoming increasingly aware of their total costs.
• Studies are finding increasing evidence of a lack of transparency.
• There is little agreement on appropriate fee structures.

Controlling asset management fees and costs has become the number one priority in institutional investment in recent years. Today, pension funds cannot make fundamental investment decisions without considering the costs associated with implementing a given strategy.

This is not just due to lower return prospects. Although the link between lower returns and demands for lower asset management charges is obvious, there are oth er reasons why investors exert pressure. Questions are being asked about asset managers’ business models, as investors raise doubts on their ability to deliver value for money. 


In Switzerland and the Netherlands, cost disclosure frameworks have emerged that have pushed investors to review their costs and seek reductions. Both initiatives are having a lasting impact on the domestic asset management industries (see other articles in this report). 

In the UK, two separate developments could potentially reshape the industry. An on-going study by the Financial Conduct Authority (FCA) promises to clarify how service providers deliver value for money. The pooling of Local Government Pension Funds’ (LGPS) assets could deliver economies of scale and increase transparency. 

The FCA’s Asset Management Market Study is a comprehensive review of competition in the industry. The interim report, released in November 2016, found that “weak price competition” was negatively affecting clients’ investment returns (for more details on the FCA review, see the news analysis on page 10 of this issue). 

As the debate intensifies across Europe and regulators enforce new rules, there is evidence that asset management fees are decreasing. But various trends are driving this, according to Luba Nikulina, global head of manager research at Willis Towers Watson. “The overall trend is of a reduction in fees. But it’s always dangerous to talk about averages. In some asset classes, such as private equity, we have actually seen the opposite trend over the past year. This is simply due to supply exceeding demand,” says Nikulina.

For investors, the ultimate objective is not just paying less in terms of management fees. Cost reduction strategies must focus on other costs associated with asset management. This requires a greater awareness of understanding of the entire value chain. “There is an increasing focus on the total expense ratio (TER) rather than the headline fee. In addition to the traditional management and performance fees you would have trading costs that can add to a very significant burden over the life of an investment. There is definitely more awareness of that,” adds Nikulina.

The issue of transparency is where the debate can get uncomfortable in some country contexts. In most reported cases of pension funds reviewing their cost structures, the funds inevitably found they were paying more than they thought. The previously unreported costs simply appeared when investors began looking at explicit and implicit costs that lie beyond the management fee.  

In response, a number of commentators expressed their outrage at the alleged lack of transparency of the industry, particularly in the UK. One of the loudest proponents of increased transparency in the industry is Con Keating, head of research at BrightonRock. Keating is also a member of the Transparency Task Force, an international group of experts campaigning for increased disclosure in asset management. 

In the summer of last year, Keating lambasted the Investment Association (IA), the UK’s asset management industry group. The IA had released a report claiming that the existence of hidden fees could not be proved conclusively. In a recent interview with IPE, Keating said: “Typically, the order of magnitude of fees that are poorly defined and invisible to the investor is about the same order of magnitude as the ones that are expressively stated.”

christopher sier

Another champion of transparency in asset management costs is Christopher Sier, a professor at Newcastle University Business School. He has focused on the issue throughout his career, working with, among others, the UK’s LGPS Advisory Board to draft its voluntary Code of Transparency. 

The code is partly modelled on the Dutch framework on asset management cost disclosure, which Sier became familiar with during his time as managing director of KAS Bank. Sier is also a member of the Transparency Task Force, and is currently working with the IA on developing its research on costs.

Speaking on a panel at the 2016 IPE Conference and Awards in December, Sier said: “The LGPS experience is a fantastic, transformative opportunity to embed transparency in a £220bn (€260bn) industry.” 

Referring to his scientific work on fees, Sier says when management fees are quoted at 1% of assets, the actual total cost can be more than 3% (taking into account implicit investment costs). This is due, he believes, to the complexity of the capital market structure, which is such that large costs are taken out implicitly along the value chain. 

Keating believes that the existence of a long intermediation chain should not have any bearing on disclosure. “But the particular aspect there is no excuse for not disclosing is transaction costs. There is a template in the Dutch system. Disclosure of transaction costs is part and parcel of the asset management process there,” adds Keating.

Transaction costs have been at the heart of the discussion in Switzerland, which implemented a compulsory disclosure framework based on TER in 2011. There are challenges associated with this approach too. 

stephan beiner

Stefan Beiner, head of asset management and deputy CEO at Publica, the CHF37.9bn (€34.7bn) Swiss institution that manages 21 public pension funds, says transaction costs are a “building block” of the scheme’s cost calculations. 

But Beiner explains: “We try to have full look through and always think in terms of net returns. However, providing a figure that includes all transaction costs, implicit as well as explicit, is a challenge. For instance, in our emerging market debt portfolio we try to calculate average bid-ask spreads, but we can only come up with an estimate. We report that estimate in the annual report, but the TER only takes into account explicit transaction costs.” 

This is the challenge Sier alludes to when he argues that TER measures fail to account for the complexity of the asset management value chain, which includes operational and infrastructure costs. 

The focus on transparency remains key, as shown in the evidence found by the UK’s FCA. In a way, transparency transcends the other burning issue: fee structures. Although there is a lively debate on what should be the appropriate fee structure, there seems to be much less progress on that question. 

Prof Amin Rajan, CEO of CREATE-Research, explains: “The long prevailing ‘heads-I-win, tails-you-lose’ fee structure, based on a fixed percentage of assets under management, has proved untenable in today’s low return/high volatility environment. It is akin to an ‘option’ in which the upside is uncapped but the downside is limited to base fee. Ad valorem fees also encourage asset gathering, with no penalty for underperformance. Where performance fees exist, reportedly they are poorly structured.”

Other variants are on the table, according to Rajan. One consists of low base fees and high watermarks, which ensure that a performance fee is only paid when the fund exceeds the highest previous value reached by its cumulative returns. Another variant includes fees being paid on a rolling three-year basis or longer, with clawbacks in bad times.

Sier suggests a structure whereby the investor pays a base fee to cover the asset manager’s costs and shares the outperformance with the manager. Keating, on his part, believes that any performance fee-based structure is potentially dangerous, as it encourages risk-taking by asset managers.  

The discussion on fee structures would probably lose significance if fees were lower in absolute terms. If the forecasts on long-term investment returns are correct, the pressure on asset managers to reduce fees and costs across the board will only get stronger. 

Readers' comments (1)

  • Good article. Point of reference for those institutions allocating to offshore funds advised by US hedge fund management companies: US tax law requires that US hedge funds recognize all fees (mgt and incentive) each year and pay the taxes due lest face a 20% tax penalty. This fact makes creating a multiyear performance fee problematic, but not impossible thanks to a recent IRS tax ruling.

    If a US manager receives options on their own fund shares in lieu of an annual cash fee then the value of the option spread is not taxable until the manager exercises its option. Think corporate stock options awarded to executives to align interests with shareholders for long term price (NAV) appreciation.

    Since the manager owes no taxes on its incentive fee at the end of the year it may leave its incentive fee pre tax in its own fund side by side the investor, and by agreement for a period longer than a year, subject to the same performance (clawback).

    Further, the option's strike price can change to create a hurdle before an incentive fee begins to accrue. The hurdle can be an index, or any agreed upon figure.

    Finally, unlike every other fee proposal that act to lower a manager's net income and potentially hurt the business model, options create the opportunity for the manager, through good performance compounding its pre tax fee on a tax deferred basis to more than make up in net after tax wealth for any other fee consession.

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