Edition: March - May 2015
Editorials

INVESTMENT CHARGES

Drive a hard bargain

Competition on fees is hotting up,
if experience abroad is anything to go by.
Retirement funds can only benefit.

The debate over the relative costs and advantages of active versus passive asset management looks set to continue until hell freezes over. So for a moment step aside from the heat in SA to take a leaf from the UK discussion. It’s provided in ongoing articles by FTfm, the weekly Financial Times supplement on fund management.

Presented is the proposition that “smart beta” – where funds attempt systemically to capture a return better than an index at lower cost – is putting downward pressure on the fees being charged by active managers. So-called beta managers load up on small companies, value stocks or low-volatility equities in the belief that portfolios titled towards these risk factors tend to outperform traditional market capitalisationweighted indices over time.

“The rapid spread of this concept is heaping pressure on active fund managers, the vast majority of whom fail to meet market-cap indices (after fees) over meaningful periods of time,” says FTfm.

A counter-argument is that any outperformance of smart-beta products is purely the result of taking on more risk, making them less obviously an improvement for risk-averse investors. Smart beta – a low-cost rules-based investment that offers to outperform at a price closer to that of index funds than active funds – merely looks like passive management.

Towers Watson, the consultancy which claims to have invented the phrase, has changed the definition: “The traditional view of smart beta is that it improves access to existing beta opportunities. For example, it provides low-cost benchmarks that are not weighted by market capitalisation.”

Now it adds: “Smart beta can also be used to describe investment strategies that offer investors exposure to different themes or risk factors, although the implementation of these concepts is still challenging.”

Research Affiliates, which manages $177bn worldwide, has popularised non-market-cap weighted indices. Its indices are weighted by such company metrics as sales, cash flow and dividends. Equallyweighted indices are also popular, as are such other varieties as low-volatility or low-correlation.

The fees of active managers aren’t immutable. The more offerings and the greater the competition, 38 Today’s Trustee March/May 2015 the more they come down. Recent research by UK consultancy bifinance has found that it pays to negotiate:

  • Fees diminish significantly as assets increase;
  • Active managers showing a genuine capability to outperform their benchmarks over time do not ask for higher fees. In fact, their price positioning is identical to that of managers less able to generate the best performance over the long term;
  • The level of management fees quoted in the first stages of a tender procedure is not set in stone. Rebates achieved through negotiation represent an average 20% off the initially quoted price;
  • Alternative methods of remuneration, based on performance fees, are not only more frequent but also better aligned with the interests of investors than they used to be.

Another challenge is thrown up by some large investment houses starting to disclose their funds’ “active share”. This is the degree to which a portfolio differs from its underlying index. The move is designed to differentiate genuinely active vehicles from so-called “closet trackers”, funds that charge high fees for active management but really differ little from passive funds.

What of passive funds themselves? Vanguard, the most prominent low-cost fund house and leader in index tracking, has again smashed the record for global asset gathering. Net inflows to the US company’s funds last year surged by 61% to $243bn.

This must be music to the ears of SA’s National Treasury, which inclines to passive options, for if and when retirement-fund reform gets a renewed lease on life.