there may be a small consolation prize for pension plan sponsors who have seen their defined-benefit assets shrink rapidly in recent months: Now could be the time to revisit the fees paid to investment managers for running a portion of corporate pension assets.
As a CFO, now could be your chance to ask your asset managers what you are really paying for, said Ben Phillips, managing director at Putnam Lovell and head of the investment bank's money management strategic research and consulting business. When your returns are dropping, but your asset-based fees are staying the same, it gives you some real leverage to perhaps negotiate lower fees, or even change the fee structures with your managers.
Mr. Phillips pointed out that many institutional investors have become stingier, and they are willing to pay top dollar only for outperformance and true managerial skill. While it's unlikely that alternative investment managerssuch as hedge fund or hedge fund-of-funds managerswould be willing to budge on their fees, traditional long-only equity managers, where investment products have grown more commoditized, might feel more pressure to bend.
They're the managers being squeezed, Mr. Phillips added. If they can't beat the broad markets, there are plenty of places to get much cheaper, more efficient beta [market] exposure.
Through the first six weeks of the year, the S&P 500 stock index had dropped by roughly 9%, and the average funded status of large corporate pension plans has declined as a result. The defined-benefit plans of companies in the S&P 1500 saw their assets decline by a combined $110 billion in January, according to actuaries at Mercer, prompting their funded status to drop by 7% to 8%. On average, these defined-benefit plans became underfunded last month, dropping to a roughly 95% funded status.
Such a significant shift has accelerated a conversation about fees that has been in progress for some time now, said Steven Miyao, chief executive officer of Kasina, a strategic consulting firm to asset managers. Whenever you have lower returns, it highlights the fees you pay to your managers. But if you're looking at the possibility of negative returns, it will force you to look even more closely at how much you are paying out.
With active equity managers, defined-benefit funds typically pay a flat fee based on the amount of assets in a portfolio. And the larger the portfolio, the lower the fee: an actively managed domestic large-cap growth portfolio with $500 million, for example, will cost institutional investors an average fee of 42 basis points, according to data from Casey Quirk & Associates. Meanwhile, the average fee on a $25 million large-cap growth portfolio is 65 basis points.
If an active manager is currently achieving only mediocre returns, yet institutional investors believe in the manager's long-term potential, pension plans may be able to negotiate to trim a few basis points off these flat fees, noted Mr. Phillips.
Another alternative could be to ask the managers to adopt a performance-based fee, suggested David Lee, a principal at Dahab Associates, an institutional investment consulting firm. In such an arrangement, the manager would lower the base fee it charges a pension plan and collect an additional fee based on its ability to outperform a predetermined benchmark.
It's more common with alternative managers, but it depends on the manager's relationship with a pension client, said Mr. Lee. Some managers might be willing to consider it right now.
While flat fees are preferable to investment managers because they provide a more predictable form of revenue, they might not have a choice but to consider performance-based fee models, said Adam Sussman, director of research at Tabb Group. When the markets decline, such a fee arrangement is a better alignment of interests. It may be a less stable way to generate revenues, but pension plans only want to pay for performance.
The prospect of lower fees has certainly been weighing on the minds of asset management executives, Mr. Miyao said, citing a recent Kasina survey of senior officials at large asset management firms.
Kasina asked these executives what they expect will shrink their margins the most in the near future. A full 45% of the executives cited declining fees as the most significant source of margin pressure, registering it as the top concern. FW