There has long been a debate in the asset management industry over the merits of active versus passive portfolio management. Buoyant equity markets over the last year have been a boon for passive investors, while active managers face pressure to both beat already-high benchmarks and lower their fees.
On April 1, Japan’s Government Pension Investment Fund (GPIF), the largest pension fund in the world by assets under management, implemented a performance-based fee structure that paid active fees according to alpha. In the absence of alpha, the pension fund would pay the manager a fee equal to that of passive managers.
Their decision to change the fee structure makes sense given the latest data on active management in Japan, courtesy of Standard & Poor’s Index Versus Active (Spiva) Japan scorecard for year-end 2017. It shows around 98% of international equity funds underperforming the index over the last 10 years, as well as 95% of emerging equity and global equity funds and 61% of all Japanese equity funds.
We asked two consultants and two fund managers whether other Asian asset owners would implement performance-based fee structures as well, and what impact that might have on the asset management industry.
Chin Chin Quah, associate director at Cerulli Associates
If you're talking about the institutions, I don't really see a trend going forward. I think they are definitely looking for returns, so performance is still very key, but I don't think they are going to pay only for performance, at least not yet. Generally, both institutions on the one hand and the asset managers on the other, are still, at least in Southeast Asia and even to some extent in North Asia, pretty used to paying the usual management fees, but not so much about paying only performance fees. Maybe they're not so advanced yet because they're not really considering this. It's growing in the US and Europe, where some of the managers have already launched performance fee-only products, but we haven't seen that in Asia ex Japan, to be honest. I don't think it's going to come so fast, at least not in the short-to-medium term.
Some of the Korean pension funds -- I think it was the Government Employee Pension Service (GEPS) -- over the past few years ... have actually stuck to managers that have not really delivered alpha, and I think they need to start thinking about getting managers to deliver performance before they actually pay them just ... based on performance. The smaller pension funds are very comfortable and used to the same names, so they tend to stick with he existing managers, although they may not perform so well.
In other markets, and among other institutions, like Malaysian pension funds, they are pretty strict, so they will actually fire the manager if performance hasn't been up to standard for the past three to five years. They will fire but they won't change the structure -- that seems to be the case for now and I think for the foreseeable future as well.
Ulrich Korner, president at UBS Asset Management
We continually speak to clients about performance fees and it’s interesting to note that not all of them embrace it. Some still like traditional pricing. I wouldn’t say there is any common trend because, for example, when clients are invested in high-performing capabilities, they are not unduly concerned about paying performance fees.
From the client’s point of view, actively managed capabilities must offer performance. If you deliver true alpha, I think you can charge a fair price for what you are doing. But if you deliver beta and try to charge alpha fees, investors won’t accept that. That is something we fully understand.
Overall, there is absolutely nothing to say against the desire of clients to pay performance-based fees. In the past few years, the active asset management industry has faced challenges such as fee pressure and the flight into passives. But if you look at markets in the recent past, they have been marked by low volatility and low dispersion, so it was easy to invest in passives. [There is] nothing wrong with that. However, with increased volatility and dispersion I think the environment for strong active managers has improved.
Elliott Shadforth, Asia-Pacific wealth and asset management leader at EY
As pricing becomes an increasingly important determinant of net new fund flows, we have seen some institutional asset allocators and asset consultants negotiating for performance-only fee structures. However, this is not yet widespread in the Asia-Pacific region. Such fee structures are intended to further align the interests of investors and managers at a time when the value for money of active management is being questioned by stakeholders.
We are starting to see some trends moving beyond cyclical changes, to more structural shifts. Managers continue to be under pressure from significant fee compression and, in this environment, the winner-takes-all phenomenon is accelerating. Those managers with competitive fee structures are increasing in size, with the vast majority of net new fund flows globally going to passive managers. While the ratio is currently more balanced in Asia-Pacific, we are seeing the larger managers in the region using efficiency and scale to drive market share and innovate towards a zero price.
Stakeholders are increasingly questioning the value for money of active management and there is a barbell developing in the market. On the one hand, the ever-increasing passive managers are attracting fund flows. However, as Asia-Pacific investors search for additional sources of income and uncorrelated returns, we are also seeing, on the other hand, solid demand for a new breed of alternative investments. These are likely to include alternatives beyond traditional hedge funds, with investors considering moving into areas including private equity, private credit, real estate and infrastructure.
Rakesh Vengayil, Apac deputy chief executive at BNP Paribas Asset Management
We see this as an emerging trend with asset owners in Asia, adopted on an experimental basis. With the implementation of this fee structure, asset owners are looking to reward active managers in proportion to the alpha they generate, while paying only passive fees for fund managers who are not able to deliver targets.
Generally, asset managers are expected to set a target for the alpha they believe they could deliver, as well as depicting the market cycle over which they should be judged.
From an asset owner's perspective, the objective in introducing the new fee structure is not to lower or save on fees, given that, theoretically, they are willing to pay more if they can get value for their money. In this arrangement, active managers who can outperform targets will be paid progressively in proportion to the alpha they generate for clients.