We need to talk about management fees

The UK regulator has criticised fee structures for active managers, but it could have effects right across the supply chain.

By Charles Gubert editors@globalcustodian.com 
The British and Irish Lions, a touring rugby union team comprised of the best of breed in England, Ireland, Scotland and Wales, was subject to a rallying call in 2013 by one of the coaches whereby he forcefully instructed the players to put their opposite Australian numbers into the “hurt arena,” which they duly did. The comparisons between the then deflated Australian rugby team and active asset managers is quite fitting, certainly in the UK.   

The UK regulator – the Financial Conduct Authority (FCA) – penned a study in November 2016 which stated active managers were not delivering value for money to end clients, and queried why there had been limited fee compression, versus the continuous lowering of fees in passive strategies.

The regulator followed this criticism with another indictment on March 3, stating a number of managers had failed to implement meaningful improvements in how they spent customer money through dealing commissions. A handful of firms, according to the FCA, were using deal commissions to purchase services deemed ineligible such as market data and corporate access.

The FCA’s position is pretty clear. Fund managers need to either pay for research themselves or create separate research payment accounts, and budget more sensibly for such costs.  This is not a huge issue for larger firms who will already employ significant research teams, but it is trickier for boutiques who are often far more dependent on external research sources.

Some had hoped Brexit would set the starting gun off for deregulatory measures, but this has not happened. The UK is a member of the EU still, and will continue to enact Directives and Regulation stemming from the EU until its membership lapses. Even after EU membership expires, the tone of recent FCA public statements to the asset management industry can hardly be described as warm.

With regulators publicly criticising fees and performance, institutional investors are going to apply leverage on managers. Many already impose significant pressure on active management fees. In a world where regulation is becoming more expensive, fund managers are facing an intimidating challenge to their business sustainability. Retail clients are also increasingly attracted to cheap passive funds, and this is probably one of the reasons behind several mega mergers of late in the active world.

Ultimately, cost pressures at managers will be felt by their service providers. The sell-side has faced a number of conversations with managers demanding more services at lower cost. This was most evident at NEMA in Dubrovnik where asset managers said they expected their custodians to maintain hot contingency networks, but were unwilling to pay additional charges for it. Fund managers point out such a service should be included in the custodian’s offering, and not be a value-add.

But service providers should not give up yet. The current low interest rate environment is forcing fund managers to reposition themselves, and identify new revenue streams. Some asset managers are lending out securities or cash collateral in increasing abundance, and this is an opportunity for banks.

More optimistically for active asset managers is that the era of incredibly low interest rates may be reaching its conclusion, and that could mean a return to profitability. This can only be good news for the custodian banks. After all, the Australian rugby team recovered its form after 2013 to become World Cup finalists in 2015.