The Struggle is Real: How Asset Managers are Coping With Fee Pressure

Performance-based fees may be attractive to both active managers and investors alike because the baseline fee is typically lower than the average flat management fee and ensures that investors don’t overpay in times of underperformance. The main consideration for managers implementing performance fees is how it will affect their existing infrastructure. Performance fees introduce complexity that may require new workflows and system enhancements to handle the new calculations. Additionally, managers need to consider how performance fees could affect reporting to investors and regulators. Managers must also have robust controls over the fee calculations, including close oversight of the service providers who typically carry out the day-to-day calculations. Beyond oversight, it is important to make sure the service provider can systemically support the calculations, to help avoid the risks associated with manual processes. Although performance-based fees may make sense in the current environment, funds with these fee models have yet to gain much traction with investors. Part of the reason may have to do with investor communication. “Performance- based fees are complex and investors don’t necessarily understand or trust them yet,” suggests Charlie Rizzo, COO Americas & EMEA, Global Head of Fund Administration, Head of US Transfer Agency, CFO of John Hancock Funds. “Communications with investors need to be clear, especially around how the fee is calculated.” Given the relatively low success of fulcrum fees, managers should consider the impact of the additional complexity before moving ahead. As Paul Kraft, Partner, US Mutual Funds & Investment Adviser Practice Leader at Deloitte & Touche LLP says, “Complexity often increases cost. Managers should evaluate if the benefit of the new fee structure outweighs the cost and potential product disruption to implement.” New fee models should be part of a larger strategy and not just a tactical response to market conditions. The Securities Lending Salve To combat eroding margins from fee compression, managers are looking for new ways to generate increased returns. A common practice by passive asset managers, securities lending is now being adopted by a growing number of active asset managers. “Securities lending presents a real opportunity for active managers. In the past year we’ve seen a number of new entrants into the securities lending market, many who haven’t lent before or haven’t lent in many years,” says David Martocci, Managing Director, Global Head of Agency Lending at Citi. Securities lending is a practice where asset managers lend their holdings to other investors for a fee. According to Flowspring, funds can generate upwards of 40 basis points in revenue from securities lending, depending on the makeup of their portfolios, which can bolster a fund’s performance and compensate for reduced fee income. In addition to the potential revenue considerations, many fund boards are also viewing it as their fiduciary duty to consider securities lending. However, implementing securities lending requires firms to create the right governance to oversee the program and the service providers who deliver it. For active managers, it is critical that the portfolio managers are consulted and buy in to the idea. “Securities lending is not just a check-the-box exercise from a fiduciary standpoint. The level of portfolio manager involvement is really going to drive the value proposition of your program,” advises Martocci. The combination of fee pressure and the search for returns means that securities lending is fast becoming an essential element of any asset manager’s strategy. “Complexity often increases cost. Managers should evaluate if the benefit of the new fee structure outweighs the cost and potential product disruption to implement.” Paul Kraft Partner, US Mutual Funds & Investment Adviser Practice Leader at Deloitte & Touche LLP “Securities lending is not just a check-the- box exercise from a fiduciary standpoint. The level of portfolio manager involvement is really going to drive the value proposition of your program.” Dave Martocci Managing Director, Global Head of Agency Lending at Citi