Poor performance by expensive external managers, particularly value and alternative risk premia funds, is leading more Asian asset owners to consider when and how to in-house more of their investment management. 

Active regional value-focused equity funds charge higher management fees than general investment strategies, yet they have generally performed worse.

 

The average stated annual fee for an Asia ex-Japan All Cap Value equity separate account was 0.8%, yet the MSCI Asia ex Japan Value Index was down -6.56% in the year to the end of August and only returned 0.9% over three years, according to research published by eVestment on August 22.

This compared to the average Asia ex-Japan All Cap Growth equity mandate charging 0.72% in fees, and the MSCI Asia ex Japan Growth Index returning 21.36% and 12% over equivalent time periods.

It is a similar story for value funds across the globe in recent years. According to eVestment, fees for value mandates among global all cap mandates were 0.81% while those for growth were 0.73%. And while the MSCI World Value index dropped 11.27% in the year to the end of August and 1.86% over the three years, the MSCI World index returned 23.68% and 18.84%, respectively.

Alternative risk premia (ARP) strategies in 2019 also suffered from poor performance, which has caused investors to criticise their high fees and be disappointed by their inability to provide an effective alternative to more expensive hedge fund investments.

According to its annual report, for the year ending March 31 the Canada Pension Plan Investment Board (CPPIB) paid its highest fees – 1.8% – to managers of C$56 billion invested in its worst performing asset class, Capital Markets & Factor Investing strategies. They were particularly hard-hit by poorly performing ARP programmes, which CPPIB noted lost C$1 billion ($760 million), mostly during the month of March when equity market values collapsed.

The next most expensive fee area was for private equity, where fees averaged 0.62%.

 

POOR SUBSTITUTE

Rich Nuzum, Mercer

Rich Nuzum, president of Mercer's investments and retirement business and a member of the consultant's executive leadership team in New York, said emerging market asset owners in particular have sought to use ARP and smart beta funds to deploy large amounts of capital following relaxation of rules concentrating investment into domestic markets in recent years.

The largest group is natural resource-based sovereign funds in the Middle East, who have found it progressively more difficult to find ways to deploy capital over the last five years as the scale of their collective assets has continued to rise.

However, many of these investors have wrongly viewed ARP strategies as offering an effective alternative to hedge funds, to which many investors have sought access but are often closed to new money, Nuzum noted. 

“Generally ARP and smart beta have disappointed many investors who had hoped to receive something like a free lunch ... the same diversification and return enhancement as a high quality hedge fund allocation might have provided, at lower cost and with more constraints on the risk being taken by the managers," he told AsianInvestor

“It would have been more reasonable to expect results to be less strong, all else being equal, in exchange for better liquidity, better diversification and less complexity."

ARP funds offer some benefits over hedge funds, he added. Institutional investors who seek large allocations, such as sovereign wealth funds, pension funds and insurance companies, can customise their ARP funds in a way they could not if allocating to a hedge fund with scarce capacity. 

In addition, investors into ARP funds commonly insisted on having separately managed accounts, using their own custodian, and imposing specific risk constraints. And while ARP funds cost more than many other equity strategies, they fees are far lower than the classic ‘2 and 20’ structure used by hedge funds. 

“While average fees have been declining for hedge funds also, those with the strongest track records and scarce capacity have generally been able to maintain their traditional fee structures,” said Nuzum.

He believes that some institutional investors into ARP and their advisers failed to consider constraints on aspects of risk including liquidity, leverage, use of derivatives or concentration of positions might affect performance.

IN-HOUSING

The poor performance of ARP and value funds could well add momentum to the trend of asset owners bringing more of their investment management in-house, especially in Asia. It will also pressurise external managers to share their skills.

Mohamad Damit Awang Damit, chief investment officer of Tabung Hajj, the RM75 billion ($17.9 billion) Malaysia’s hajj pilgrims fund, told AsianInvestor in August that the ability of external managers to help train internal staff was a very important factor when considering appointing them.

“We use them to generate alpha but also to help us to develop talent, to add value to our talent pool and for knowledge transfer,” Damit said, adding that the asset owners was constantly internalising the processes it saw from external managers, and using their skills to refine its internal process.

Nuzum said the process of moving investment decision-making in house was easier in Asia than in the US, where political pressures make paying in house staff at state or municipal public pension funds harder.

“Asian stakeholders tend to focus more on returns net of costs,” he said, noting that requirements in Asia to publish the salaries of asset owner’s top earners remain rare compared with the US, while the earning power of financial professionals is generally less politically sensitive.