Fundie fee pressure hits private markets

For decades the active managers of public market equity funds have grappled with fee compression driven by low-cost competitors such as index funds and by a zero interest rate policy environment.

Now, that fee pressure is spreading to other asset classes, including fixed income, emerging market equity, “impact” strategies and private market assets, analysis by investment consultants bfinance has uncovered.

The Investment management fees: Pricing pressure in the turbulent twenties report found that the median quoted fees for sizeable mandates has fallen 13 per cent in global emerging market equities, 12 per cent in European high yield credit and 14 per cent in global impact equity since 2022.

The spread of fee compression raises deeper questions about whether the investment industry can maintain its pricing power, particularly in premium products such as private markets.

“The profitability of the asset management sector has remained under pressure since 2022, with average operating margins staying around 30 per cent,” it says.

“While high compared to many other industries, this figure continues to sit considerably beneath pre-2008 levels: before the Global Financial Crisis, average operating margins regularly sat near or above 40 per cent.”

This is despite a surge in revenues driven by assets under management (AUM) in the 2020s “thanks in large part to soaring capital markets”. Traditional asset managers have pivoted to higher-fee alternatives, and a wave of consolidation in private market sectors should have led to improved efficiency and resilience.

“Yet these tailwinds have not translated into higher corporate profitability, beyond a sharp-but-brief post-pandemic spike driven by a growth in assets under management,” bfinance says.

“Several factors, including rising non-personnel costs (such as unprecedented technology spending), have contributed to the apparent stasis.

“One key question facing the asset management industry is whether premium (high fee) asset classes and strategies will shore up asset manager profitability going forward or, conversely, whether these same strategies are especially vulnerable to future fee compression,” the report says.

The factors driving down fees across asset classes outside public equities are quite different from those that undercut active managers in that asset class, the report says.

“The higher-for-longer interest rate environment has reshaped the competitive landscape in fixed income, with active ETFs becoming more prominent,” the report says.

“More concentrated equity markets, increasingly dominated by large U.S. technology stocks, have affected investors’ priorities and perceptions of performance, with systematic or enhanced core strategies often beating their more expensive peers.

“Private market managers are under pressure, driven partly by weak distributions and exit activity in a higher-rate era, but sector-wide pricing shifts are obscured by the complexity and low transparency of discounting (or effective discounting) arrangements.”

Systematic strategies, particularly enhanced index and multi-factor approaches, have on average beaten their benchmark in each of the last five years, while fundamental active managers have struggled to keep pace, bfinance says. The systematic strategies are priced above smart beta and passive products but below ‘classic’ active management.

The report adds that the accelerating emergence of AI is a new factor that is “already affecting the products available to investors and may drive pricing developments over the coming years”.

The report says that while investors, including asset owners, may find opportunities to seek improved value for money for members from the ongoing fee compression, they should not be complacent and will need to take a highly nuanced approach.

“We believe that the strongest fee negotiations are not based on headline data points alone, but on nuanced assessment of the specific strategies, market participants and prevailing market conditions, as well as the quality and recency of the underlying data,” the report says.

“Strategy type, vehicle structure, mandate size, client type, region, performance objective and mandate-specific requirements can all affect comparability. Meanwhile, the specific circumstances of the investor, the fund manager and their relationship may heavily influence negotiation.”

The report warns asset owners to be wary, and while pricing power may have shifted towards allocators and away from managers, “not everyone will benefit”.

“In private markets, for example, the shift is masked – typically manifesting in more aggressive discounting practices rather than reductions in stated fees – and strongly favours large, traditional institutional clients versus smaller institutions or newer entrants from the wealth sector,” it says.

“Meanwhile, cost transparency remains problematic in sectors where real fee improvements would make the greatest difference to the bottom line. The ongoing tension between cost-seeing and cost-setting demands continual innovation in benchmarking and governance.”

The report says asset owners must continue to demand “alignment of interest and value for money, even in less commoditised sectors where both price and performance are harder to benchmark”.

“Asset manager profitability, while important to industry health, should not come at the expense of clients’ best interests,” it says.