In this article I outline a few of the issues, some of which, namely what fees might be subject to volume discounts, were covered in an earlier article (IFA, August 11, 2003).
The perspective here is that of a wholesale investment manager. There are three main components of the service provided by investment managers:
1. Providing access to capital markets – the price of which is often referred to as index fees, or fees for beta. These are typically relatively low for most listed market investments. Except for pricing operating risk, which is assets under management (AUM) linked, the fees can be viewed as a dollar cost. Hence, when expressed as a percentage of AUM, these fees are lower the higher the AUM.
2. Active management. These are fees for a targeted level of outperformance. Outperformance of 2 per cent on $10 million is $200,000, whereas 2 per cent on $100 million is $2 million. Hence, the fees for $100 million will be proportionately higher than the fees for managing $10 million. Delivering positive active returns on a consistent basis is very difficult, requires costly resources and successful strategies have limited capacity. These fees tend to be a percentage of AUM, with little or no discount for higher AUM.
3. Client service, marketing, administration and other support. These fees depend on the type of support required. They tend to be linked to the number of clients or transactions and the type of service required. When expressed as a percentage of AUM, these fees tend to be lower the higher the AUM.
The fees for investment management of a hypothetical active equity strategy made available to various types of investors, with some assumed levels of client service support are shown in Table 1.
Actual fees depend on the quality of the strategy, competitive forces and levels of support required. In this hypothetical example, fees for direct access by professional investors (amounts greater than $500,000) are 0.9 per cent a year. The fee for an institutional client investing $100 million might be 0.5 per cent a year, because two of the components of the total fee (access to market and client service) are significantly lower when expressed as a percentage of AUM. Often the fees for funds accepting only institutional investors are directly invoiced (rather than deducted within the fund).
When multiple retail investors are aggregated together by a dealer group or platform, resulting in a $100 million investment, the fees will lie somewhere between the 0.9 per cent of the individual $500,000 investment and 0.5 per cent of the individual institutional investor. This example assumes conferences, professional development days, administration and client support associated with the platform/dealer group have a cost of (say) 0.21 per cent a year across the $100 million.
Typically for funds accepting professional and platform investors, the 0.9 per cent fee is deducted within the unit price of the fund and hence to get to a lower fee (as appropriate for the platform’s AUM), some of the 0.9 per cent must be refunded, in this example 0.2 per cent. This is where the issues start to arise. Two alternatives are: 0.2 per cent refund to the platform through which the investment is made, and 0.2 per cent refund to the dealer group whose financial advisers are responsible for the underlying investors whose $100 million has been invested. Where the platform and dealer group are related entities, it makes little or no economic difference where the refund occurs.
Where the platform is used by multiple independent dealer groups it does make a difference where the refund occurs. Some further issues are: If a refund is provided to the platform, should this be passed on (in part or whole) by way of a commission paid to the dealer groups responsible for the AUM from underlying investors or rebated directly to the underlying investors through lower fees on the fund? Is there a difference between a 0.2 per cent refund on the $100 million or a 0.15 per cent refund and $50,000 payment to the platform via shelf space fees? Can refunds received by platforms be passed on indirectly to investors through lower platform charges and/or through providing better service to the underlying dealer groups and financial advisers?
It is a competitive market. Driving most pricing decisions is competition at the level of platforms, dealer groups, financial advisers and investment managers and it is also influenced by other market participants such as industry funds. Just as important, there are considerations of transparency and the extent to which industry participants disclose fees and remuneration arrangements and manage any potential conflicts of interest, recognising that most of the participants have fiduciary responsibilities and are regulated licensees.
Directly or indirectly, competition at each stage of the service chain is driving down the total fee paid by the investor or driving up the level of service. How the end solution is achieved is never static.
