Funds paying over 50% more investment fees than five years agoSydney, 28 February 2008 – Superannuation and pension funds around the world
are paying on average 50%1 more in fees2 than they were
five years ago according to research by Watson Wyatt, the leading global
consulting firm. The research found that fees now average around 1.1% compared
with around 0.65% in 2002, with the vast majority of these costs being paid in
fees to external investment managers and brokers.
Graeme Miller, Head of Investment Consulting at Watson Wyatt Australia, said:
“One of the main reasons for this upward cost spiral is investors’ focus on
‘alpha’3, which has increased their appetite for alternative assets.
Investors have naturally assumed that they are paying these fees to reward
manager skill, but in many cases they are wrong.”
In a research note entitled ‘A fairer deal on fees’, the firm says
that many pension funds have been paying ‘alpha’ fees for ‘beta’4
performance because the main driver of returns in recent years has been the
strength of the markets. This has encouraged investment managers to leverage
their portfolios to boost returns, which means that investors are often paying
for leveraged beta (market returns multiplied by gearing).
Graeme Miller said: “This is obviously a good deal for investment managers,
but not necessarily for their investors. While we strongly believe managers
should be fairly compensated, fees are currently too high for the value they
deliver—particularly as we enter a lower-return environment. Also, performance
fees introduced to align interests have been less than effective because they
are generally poorly designed and tipped in managers’ favour.”
In the note the firm identifies a number of flaws in investment manager fees,
including:
- Base fees are currently generally calculated as a percentage of funds
under management, which encourages asset gathering and can harm performance
- Annual performance fees can amount to a free option for the manager, as
the upside is uncapped but the downside is limited to the base fee
- Fees can also be paid on money waiting in cash to be drawn down for
investment
- Many leveraged real estate managers charge fees on the gross exposure
rather than committed capital
- Fees charged by fund of funds can use a combination of these flawed
approaches and in many instances lack transparency.
Graeme Miller said: “In the recent past, many trustees have unwittingly paid
away the vast majority of their ‘alpha’ in fees, surprisingly even when their
fund managers have performed particularly well.”
According to the firm an ideal fee structure should have a low base fee to
cover costs and a performance fee which should be calculated over longer periods
(typically three to five years), include ‘ghost’ years and have hurdles and
high-water marks. In addition, total fees should never be more than 50% of alpha
and costs should formally be included in funds’ risk budgets. It also says that
fee structures should not be standardised across the industry in view of the
increasing diversity of investment strategies and mandates.
Graeme Miller said: “This is a complex area, which doesn’t mean it should be
glossed over as too much value has already been allowed to leak away. There are
signs of change as we move into a different market environment where many
managers will no longer be able to justify their charges without beta to bail
them out. In future, active managers that wish to win mandates from
superannuation funds must offer them a fairer deal'.
About Watson Wyatt
Watson Wyatt Investment Consulting, a division of Watson Wyatt, is focused on
creating financial value for institutional investors through independent,
best-in-class investment advice. We are specialist investment professionals who
provide co-ordinated investment strategy advice based on expertise in risk
assessment, strategic asset allocation, and investment manager selection. Watson
Wyatt Investment Consulting provides investment advice to some of the world’s
largest pension funds and institutional investors, and has more than 450
associates in Europe, the Americas and Asia.
In Australia, Watson Wyatt is the leading investment consultant to institutional
investors, and advises clients with assets in excess of $200 billion. It has
offices in Sydney and Melbourne.
Watson Wyatt (NYSE, NASDAQ: WW) is the trusted business partner to the world’s
leading organisations on people and financial issues. The firm’s global services
include: managing the cost and effectiveness of employee benefit programs;
developing attraction, retention and reward strategies; advising pension plan
sponsors and other institutions on optimal investment strategies; providing
strategic and financial advice to insurance and financial services companies;
and delivering related technology, outsourcing and data services. Watson Wyatt
has 7,000 associates in 32 countries and is located on the Web at
www.watsonwyatt.com.
For more information contact
Sonja Lee
National Marketing Manager
Telephone:+612 9253 3176
sonja.lee@watsonwyatt.com.au
1There were some methodological differences in the research
between 2002 and 2007.
2Fees include investment management fees, brokerage, custodian,
performance measurement and consulting fees and other transaction costs.
3‘Alpha” refers to performance in excess of market benchmarks.
4‘Beta’ refers to the aggregate level of return earned by markets,
and excludes any value added or subtracted by managers through active
management.
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