State funds demand more detail on returns, fees

Sovereign investors such as Australia’s Future Fund are leading a wave of asset owners pushing asset managers to provide more disclosure of equity performance drivers and fees, as market-outperforming returns continue to decline.

“The most sophisticated investors are initiating a lot more discussion around fees and holding managers more accountable for what they are charging,” said Paul Price, global head of distribution at Morgan Stanley Investment Management.

“We’re being asked to decompose some of our equity portfolios. Clients are asking for more detail on performance attribution,” he told AsianInvestor, and it makes sense for them to do so. It seems they are prepared to pay 20% to 25% fees for genuine outperformance, he noted.

This trend is being driven by many of the sophisticated sovereign wealth and pension funds, added London-based Price, partly because they are public bodies that need to justify the fees they are paying.

“The fee discussion is pervasive, it’s everywhere,” he said. “There has to be more of a correlation between the fees paid by investors and the amount of alpha they're getting.”

Seeking portfolio control

The Melbourne-based Future Fund is at the forefront of these talks. The Australian sovereign wealth fund has ramped up its focus on performance attribution since bringing in Bjorn Kvarnskog as its new head of equities early last year. He has been reorganising its portfolio. 

The A$133 billion ($104 billion) fund is seeking to delineate more clearly the broad risk premium it gains from beta—or market returns—in its equity portfolio, chief executive David Neal told AsianInvestor. It is also building an alternative beta portfolio and managing the active component very tightly to avoid paying excessive fees for beta or alternative beta that can be obtained much more cheaply,  he said.

Alternative beta involves using rules-based factors (incorporating long/short strategies) other than traditional market-cap weighting to generate different—and ideally higher—returns than those provided by market cap indexes.

Neal said the fund should understand and “own” the exposure to these factors. “We should understand what they are, how much we’ve got, how they are configured and that we can build that technology ourselves, though we would continue to execute it through external managers.”

“We are part of that wave,” he added. “It’s about asset owners like ourselves taking more control of the portfolio and making sure we’re paying external parties only for the value they add. And I think that that will continue across the industry.”

Low yields 

As it has become harder to generate alpha (above-market return), what investors pay has become more important.

“If you’re getting a 15% to 20% return, you might not scrutinise where each increment of return is coming from,” said Gary Smith, head of sovereign wealth funds and official institutions at Baring Asset Management. “But that changes if you’re only getting 3%j to 4%.”

Price noted that, for large mandates, institutions are driving the cost of beta down to as low as five to 10 basis points. “The big question now is how much you're spending on alpha, and what’s a reasonable price to pay.”

The typical amount being paid for outperformance is now around 20% to 25%, he said. “That’s where pricing is going for long-only equity mandates.”

This doesn't mean the end of ‘ad valorem’ fees (those based on a percentage of asset value) for a standard portfolio, noted Price—but they should be justifiable.

“If a manager charges you 60bp (basis points) for a mandate, you should expect them to be giving you 300bp to 400bp-type returns.”