It’s now conventional wisdom that investors are hitting back hard against high fees, but half of respondents to a recent survey say they have no idea whether the arrangements they’ve negotiated with asset managers are actually working to their benefit.
According to survey data provided exclusively to Institutional Investor by Chestnut Advisory Group, which provides business development consulting to asset managers, about half of respondents don’t understand whether the discounted fees combined with performance incentives that asset managers have provided are better than standard prices. In addition, almost half of investors are not sure whether or not managers with incentive fee structures are taking additional risks to trigger those fees. Chestnut interviewed more than 70 investors for the research.
The asset management industry, particularly hedge fund firms and other active managers, has come under fire for high fees, with analysts predicting a future of slow growth amid an onslaught of new, lower-fee competitors.
[II Deep Dive: Report: Active Managers Face a New Threat]
“Highly negotiated structures end up getting complicated very quickly and are hard to follow,” says Amanda Tepper, Chestnut’s founder and CEO. “Most investors can’t tell you what they’re paying for their portfolios. There is a laser focus on fees when hiring a manager, and then it goes away completely until a board member says ‘let’s do an audit.’”
Tepper adds that every large institutional investor who allocates money to both alternative investment firms and traditional long-only managers wants discounts on stated fees as well as performance incentives. Investors think an incentive fee can better align a manager’s goals with the investor’s objectives than an asset-based price tag alone.
When investors were asked if they pay less in fees when they negotiate an arrangement of discounted base fees plus performance fees, only 30 percent estimated that they end up paying less than published rates. Forty-nine percent were not sure if they saved money on the negotiated rates or not.
Chestnut advises money managers to communicate on a regular basis about fees with clients, even though few want to bring the subject up.
“No manager wants to talk about fees. But there’s a value proposition here,” says Tepper. “Every year managers should say, ‘This is what we’ve done. You saved X, say, because you bought us right before we went into a downturn.’”
With few investors knowing what they pay for money management, Chestnut also advises managers to detail the additional services they provide.
“Allocators want the sun and the moon. They want access to portfolio managers, people to fly to board meetings, and asset allocation advice. There is a cost to this,” says Tepper.
Chestnut recommends that money managers detail everything from dinner invitations with portfolio managers to the questions answered for the board.
“If you don’t articulate it, you’ll be viewed as a commodity and then it just becomes a fee game,” she says.
Chestnut also found that for investors with more than $5 billion in assets, 48 percent always negotiated fees with managers. For investors with under $1 billion, only 13 percent always negotiated fees.
Tepper says there is a myth that fees are investors’ number one concern. Only 42 percent of respondents said fees were among the top three reasons that they selected a manager.
Still, Tepper says managers often think that if a new product doesn’t do well that it’s because fees are too high. She says two Chestnut clients launched funds with lower fees after getting feedback from investors that the price tags were high. But the funds still had trouble raising capital.
“The issue wasn’t the fee,” she says. “That’s just the easy response from investors.”