Fees: why managers may take the see-saw or slide

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Both active and passive fund managers may have to adjust pricing models this year with the emergence of two new fee trends: ‘free’ and ‘fulcrum’, according to a new report by global consultancy Deloitte.

The report says the launch of the first zero-fee index fund last year – by US firm Fidelity – “was a seismic shift for the industry”. But, in less earth-shattering news, institutions still plan to squeeze out a profit from the growing pool of index money despite the removal of explicit upfront fees.

“With other investment managers also following suit with the launch of zero-commission platforms, firms’ revenue-generation focus now moves toward securities lending, order-flow payments, and shareholder-servicing fees,” the Deloitte ‘2019 Investment Management Outlook’ says.

Large-scale managers may also use the fee-free index offerings as a lure to “keep investors within the fund family”, the report says.

And as passive funds slide down to zero, active managers may have to exchange the fee roundabout for the see-saw as the ‘fulcrum model’ comes into vogue, Deloitte says.

Under the fulcrum approach managers charge a low base fee if the fund underperforms its benchmark.

“If the fund achieves alpha, an additional performance fee is charged,” the paper says. “Such variable fee structures may create a win-win situation, delivering better net returns to investors and incentivizing fund managers on performance.”

The Deloitte report cites the UK arm of Allianz Global Investors as one of the first active managers to adopt the fulcrum model with a base fee of 20 basis points balanced against a 20 per cent take of any outperformance.

“This trend could accelerate with more than 10 firms adopting this pricing approach in the next 12-18 months,” the study says.

Deloitte also says diverging customer preferences (hastened by the rise of post-babyboomer generations), global regulatory challenges and technological disruption will put pressure on traditional investment management firms to adapt.

Fund managers need to carefully choose growth strategies in the new era with a number of approaches to consider, including:

  • acquisitions
  • global partnerships
  • expansion of alpha-generating tools such as using “alternative data sets”, and
  • new products built on sharp pricing models, artificial intelligence or environmental, social and governance (ESG) parameters.

Furthermore, managers will have to improve operational efficiency – via technology (such as data analytics), cost controls and “investing in talent” – while also creating the “next level of customer experience” now considered mandatory in the digital age.

“Investment management is in a period of rapid change, driven by shifting investor preferences, margin compression, regulatory developments, and advancing technologies,” the report says. “While the nine-year bull run has diminished the intensity of these industry challenges, experience tells us that markets work in cycles.

“Successful investment managers (which we define as managers of mutual funds, hedge funds, and private equity firms) in 2019 will likely be the ones that can continue to manage these challenges with plans designed to withstand changing market conditions.”

– David Chaplin, Investment News NZ

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