The debates over the failures of active managers and parallel growth of passive investment often neglect two important facts. First, passive investment may be growing faster but it is still dwarfed by active.
However, the poor record of active managers, especially in recent years, is a sobering reality for any stockpicking enthusiast. Active-management firms must fight to defend their case.
For those on either side of the debate, it is refreshing to discuss the matter with Andreas Utermann, CEO of Allianz Global Investors. It would be hard to find a more passionate supporter of active management. However, he starts with the candid admission that the asset management industry has a reputational problem. “There is a perception that too much of the value that is created, if there is any, is taken by the asset management firm,” says Utermann.
The root of the problem, he argues, lies in the fundamental flaws of the fixed-fee model that is prevalent in the industry. “It almost guarantees sub-optimal outcomes for the end client,” he says.
The premise is that every actor in the system, from the salesperson to the end client, behaves pro-cyclically. This means that the bulk of the assets are invested with managers and in asset classes that have done well and will, sooner or later, underperform. “It’s a disaster, because it means that during underperformance the value chain works in reverse. Nobody owns the investment performance,” says Utermann.
The other well-known flaw of the fixed-fee model is that it incentivises fund managers to break through the optimal capacity level for their strategy.
“Perhaps I am exaggerating, but it feels as though the whole system is geared towards generating fees through constant turnover of strategies, which leaves little value for the client,” he says.
The answer is simple: performance fees. Utermann argues that performance fees address the wider problem, which is that the industry has built, by and large, arm’s-length relationships. Fixed fees mean short-term partnerships, while the converse is also true. Performance fees, instead, allow for longer-term relationships.
“Performance fees allow managers to be fully focused on generating value in the long term. They take out the pro-cyclicality of the system that destroys value,” says Utermann.
AllianzGI has started to offer its clients performance fees along with fixed fees as a way to achieve better alignment of interest, and the concept has resonated reasonably well. The conversation is relevant to traditional asset classes, where fixed fees are prevalent. In 2017, the company made 10% of revenues through performance fees. The figure takes into account revenue from alternative strategies that, by default, involve performance fees. But the point is that the performance fee model is being rolled out across the board.
“It will be a slow growth path, but eventually it’s going to flip completely in favour of performance fees,” Utermann adds. “This is much more than a fee model. I see it as a strategic reorientation of the whole industry.”
The decision to offer performance fees means, among other things, that many investment strategies offered by AllianzGI’s have AUM limits. This is not always popular with clients, Utermann says. There are also conversations with the parent company about revenues, but the CEO says the unpredictability of revenues that comes with performance fees will be manageable. The parent understands that this is a long-term story. “They can see AllianzGI is out there addressing the relentless pressure on active managers head on,” he says.
“Plus, we are not suggesting that performance fees are the answer for every client. Some are perfectly happy with the fixed-fee model,” adds Utermann. He points out that the fixed-fee model works well in jurisdictions where advice fees are paid out of management fees.
The strategy certainly shows AllianzGI is serious about active management. Such steadfast commit-ment, combined with the firm’s growing capabilities in alternative investments, seems to win over clients. The assets managed on behalf of third-party clients have grown 89% between 2012 and 2017, according to a company spokesperson.
Like the vast majority of its peers, AllianzGI is also eager to show that its ESG credentials are strong, since the firm’s focus on this area has grown.
As of June, €116bn of assets invested in what it calls ‘integrated ESG’. That label applies to portfolios that are managed taking ‘financially material ESG factors’ into consideration but without constraining the investment universe. A further €22bn of assets carry the SRI label, which signifies a more direct best-in-class approach. The company has also €6bn-worth of impact-investing strategies.
The remaining €380bn are ‘ESG informed’. This essentially means portfolio managers are not obliged to consider ESG factors when making investment decisions. However, proprietary ESG research is made available to all via the company’s ‘Chatter’ tool, a digital platform used to share research and record conversations between portfolio managers. In general, active stewardship is an integral part of the firm’s investment strategy. This applies whether or not individual portfolio managers see ESG as a factor.
However, Utermann says: “Just as there are clients who don’t believe that ESG should be factored in, we also have portfolio managers who don’t believe that. So if the CIO of a particular strategy wants to focus on traditional valuation work, and the client agrees, we’re not going to tell them to do it from the top down. We wouldn’t be doing anybody a service. We have to work on ESG integration strategy by strategy.”
But the demand from clients is clearly growing and the firm has to react, says Utermann. Furthermore, the firm sees ESG factors as a value-add to investments. “This ties into the active management discussion. As an active manager, how do we differentiate ourselves from a passive product? If we incorporate ESG factors, we add value that is difficult to replicate in an index form,” he says.
That is why that €116bn of ESG integrated assets is bound to grow rapidly over the next few years. “If you are truly wedded to active management, as we are, then I would argue that over time more comprehensive ESG integration is a must,” says Utermann.