THE RESILIENCE OF ACTIVE FEES
Despite this expensive underperformance, the FCA’s analysis shows that active management fees have remained pretty much unchanged for the last 10 years. In contrast, passive fees have come down, opening an increasing value gap between the two approaches.
Active managers often argue that their fees are higher, not just because of the greater overheads they incur, but also because of their unique investment approach. Different managers’ approaches to the same asset class will vary considerably. This makes it difficult for a client to conduct an apples-with-apples comparison between managers to ascertain who represents the best value. The huge variety of different terms and names for each approach will further hamper efforts to conduct a thorough analysis.
According to Pitmans Trustees (PTL) managing director Richard Butcher: “When an investor is comparing passive managers, there is very little value judgement as they would all be expected to produce very similar returns. Active comes in all shapes and sizes and they all justify the differential in price by what they do. This makes it a more opaque comparison as they are not competing to achieve the same objective. What you end up with is opacity on top of opacity, which makes it harder to compare and harder to negotiate. Managers are almost inevitably hiding behind that opacity.”
IS TRANSPARENCY A PANACEA?
The recommendations made by the FCA in its report, perhaps unsurprisingly, focus in large part on increasing transparency around costs.
According to Kas Bank transparency specialist Stewart Bevan: “There absolutely needs to be greater transparency around costs, they are an essential part of effective governance and informed decision making. Most investors don’t know the true costs they are paying for their pension scheme and the impact those costs can have on long-term outcomes.”
Bridgeland meanwhile, believes improving transparency is key. She says: “Most people will have looked at the true costs of active management and realised there is a lot
beneath the surface. They may be shocked at how much is beneath the surface though.”
Transaction costs have come into particular focus in this regard, especially given that they are generally greater for active versus passive funds and, according to the FCA, can add up to 0.5% of the total cost of owning a fund. Comparable and mandatory reporting of transition costs would “undoubtedly change the market place”, according to Pan Trustees director Roger Mattingly. “There should also be a strategic value-formoney statement by all pension fund boards – there shouldn’t be a distinction between DB and DC,” he adds. “It then becomes the chairperson’s duty to actively
assess value-for-money and ensure that is what they are getting. Transparency goes hand-in-hand with this.”
But transparency on its own won’t be enough to drive down fees. Standardisation is at least, if not more, important because transparency needs standardisation to be effective. Slippage costs, for example, could be a standard disclosure, but you also need to have standardisation in how that is calculated. Otherwise, PTL’s Butcher says, it’s like “running 95 metres of a 100 metre race”. “Both the method of disclosure and the method of calculation need to be standardised,” he says.
Transparency is naturally the first hurdle in gaining greater standardisation, but the two must come hand-in-hand if comparability is going to increase to the extent that it can drive down costs by making fees a competitive factor. Greater transparency and standardisation would also more clearly align the interests between fund manager and client in keeping costs under control. Weak price competition tends to lead to weaker cost control and shining a light on costs would certainly encourage fund managers to more closely monitor costs, even where it is more expensive for them to do so, such as trade execution.
THE COST OF BEHAVIOURAL BIASES
However, transparency and standardisation are not the only solution to creating more effective competition in the fund management industry. After all, current levels of transparency and standardisation are the same for both active and passive funds so this cannot be the only factor in the different competitive environments. Investors’ behavioural biases also play a role in keeping fees for active management high.
According to Robert Gardner, founder and director at Redington: “We see a disconnect in how closely fees are scrutinised. Costs for LDI mandates, where the fees are already low, get a lot of scrutiny, but then in private equity, there is very little scrutiny on fees. Historically, the mind-set was that active should outperform passive and people tend to think they are good at picking good managers.”
