A new study from bfinance, the independent investment consultancy, has revealed that institutional asset management fees have fallen significantly in a number of asset classes – particularly certain ESG or Impact strategy types.
Pricing compression is evident in well-established strategies such as ESG Equities and Renewable Energy Infrastructure. Meanwhile, newer strategy types such as Impact Equities and ‘Article 9’ funds are offering substantial discounts versus rack rates.
This biennial survey reviews a range of asset classes and strategies, identifying notable fee reductions in certain strategy types and sub-sectors.
The study’s key findings include a reduction in the cost of active global Equity strategies with ESG requirements, where the median fee for a EUR100 million mandate has decreased by 14% since 2016. More managers have entered the space through a period of ‘ESG mainstreaming’, resulting in heightened competition for assets and a refinement in pricing. Although very new manager research suggests that there could be a modest premium for Impact and Article 9 Equity strategies, managers in these more nascent sectors are more likely to offer substantial up-front discounts even before negotiation, as they seek to build up assets.
Elsewhere in the ESG-related landscape, management fees for Renewable Energy Infrastructure (“Renewables”) strategies have fallen by 8% since 2016 and performance fees have also declined—through a period when fees for Infrastructure strategies and Private Markets strategies more broadly have remained remarkably resilient.
When looking at other strategy types, US High Yield saw median fees decrease by 15% since 2017, while fees for blended Emerging Market Debt strategies decrease by 10% in the same period. Multi-Sector Fixed Income also saw its median fee decrease by 15% since 2017.
Fund of Hedge Fund fees declined very substantially, falling by 42% between 2010 and 2019, but this decline now appears to have stopped. While fees for Private Markets strategies have remained relatively resilient, a closer look at fee models does reveal some helpful changes: Direct Lending fees, for example, are now almost universally charged on invested capital only rather than on both invested and committed capital.
The price of ESG and impact
The research from bfinance finds that investors today can benefit from a notable erosion in fee levels for a number of ESG and impact-oriented strategies. Some ESG-related sectors are now becoming relatively mature, often characterised in pricing terms by narrower dispersion in fee quotes and more clustering around certain fee-points as well as overall price compression.
Active global equity managers that integrate ESG considerations are now quoting significantly lower fees to prospective clients than five years ago. The median fee quoted by managers on EUR100 million mandates has declined by 14% since 2016, from 57bps to 50bps.
The study found that the rapid reduction in the number of active global equity strategies that do not integrate ESG considerations has negated any potential ESG pricing premium in this asset class.
Dedicated thematic and impact equity strategies
There are some interesting patterns in pricing of Impact and Thematic equity strategies that investors may consider as they explore these emergent sectors and negotiate fees. For example, recent search activity in this space (Q4 2021) suggests that there may be an on-paper premium on the pricing of Article 9 strategies, with a slightly higher median and a significantly higher upper quartile fee than we observed in Article 8 strategies.
However, this area also featured some of the most aggressive discounting against those quotes, with nearly 30% of the managers proposing Article 9 strategies offering an upfront discount (i.e. discount provided alongside quoted fee in first proposal). These upfront discounts are primarily available from managers whose pricing sits above the median. In these cases, managers are often seeking seed investors and competing to gain a foothold in this growing space.
There may also be a modest premium (or at least a higher median quoted fee) for Impact strategies, which explicitly target and are equipped to report on social and environmental outcomes. ‘ESG thematic’ strategies that do not meet the threshold which we would consider appropriate for an Impact strategy were, on average, a little cheaper in terms of quoted fees.
Renewable Energy Infrastructure
As the Renewable Energy Infrastructure sector has matured and developed, investors have benefitted from some significant fee reductions—contrasting with stable infrastructure pricing in other sectors.
The research found a modest reduction in quoted base fees for global Renewable Energy Infrastructure strategies, with the median quoted fee for a USD50 million mandate down 10bps versus 2016 (-8%) and a fall of 21bps in the upper quartile (-14%). The survey also saw significantly less dispersion in the fees being quoted by managers—a pattern that is characteristic of a maturing sector, where price discovery over time leads to a greater awareness of what competitors are likely to charge for similar products and a reduction in the more extreme quotes.
Importantly, performance fees and hurdle rates have also fallen. While many managers are at the 20% mark on carry, we do see an increasing proportion willing to price between 10% and 15%. In addition, the median hurdle rate has declined to 6% from 7%. There is a positive correlation (albeit a weak one) between base fees and performance fees being quoted by managers: strategies with higher base fees tend, on average, to have larger performance fees as well.
The decline in fees has been accompanied by a fall in target returns, as well as a rise in the proportion of longer-term vehicles versus ten-year private equity-type fund models. The median net IRR being targeted by funds raising capital in 2021 was 8%, down from 9% five years before).
Impact real estate
The fee quotes in Impact real estate are extremely diverse, reflecting the range of strategies that straddle Core to Value-Add profiles, though the study saw some base fee clustering around the 100bps and 65bps levels. Core strategies tend to be cheaper with no performance fees, while all Value-Add strategies have some form of a performance fee. For some managers, the performance fee relates to both financial and impact objectives, while for others it is purely financially focused.
Return targets are also very diverse and are not particularly strongly correlated with quoted fee levels. Managers in this sector seem unsure about how to price, and investors are unsure about what return expectations are appropriate and realistic. Some investors may have reputational concerns about targeting relatively high returns for an asset class that is, fundamentally, involved in the lives of vulnerable
population groups. This diversity can, however, be helpful for investors that are keen to ensure that they do not overpay. The large number of start-up funds in the space and the low transparency around pricing can give well-informed clients a strong hand in negotiations.
Identifying potential fee savings
Comparison of existing fee levels against those available in a broad strategy area (e.g. “global equities”) can be useful as part of a fee review process. However, it may also be beneficial to seek a more detailed view and examine specific peer groups based on their structure, geography, strategy subtype and more.
Looking closer at structure
Example: US high yield in a UCITS structure
When we look at the period 2017–2020, we see some of the strongest pricing reductions in US High Yield strategies offered in a UCITS structure. In 2017 there were fewer offerings in this area. Managers have subsequently prioritised the diversification of their client base, with UCITS funds allowing easier flows of capital from European investors. Firms are now more firmly committed to this dimension of their businesses. With this maturation and expansion in providers we see that median fees fell by 8bps over a three-year period (-15%) and the upper quartile declined by 10bps (-17%).
Example: multi-strategy hedge funds via ‘platform’, ‘non-platform’ and ‘FoHF’
Demand for ‘multi-strategy’ among bfinance clients has risen dramatically—30-40% of new hedge fund searches launched on behalf of bfinance clients in the 12 months to September 30, 2021, were multi-strategy mandates.
Alongside conventional FoHFs, with their double layer of fees, we see so-called ‘platform’ multi-strategy approaches (in which the manager actively controls exposures to sub-strategies) and ‘non-platform’ multi-strategy approaches (in which the investor has exposure to a range of strategies at one manager but without the same degree of active selection/management of exposures). Total Expense Ratios for multi-manager platform structures can add up to nearly 5% depending on the fee pass-through. Non-platform approaches, on the other hand, can end up being significantly cheaper.
Looking closer at: strategy sub-type
Example: Blended Emerging Market Debt
The median fee has declined from 50bps to 45bps in a three-year period (-10%), while the upper end of the range has dropped from 80bps to 67bps giving a considerably narrower range of quotes—typical of a maturing segment that has passed the price discovery phase. This decline is perhaps particularly notable when we consider that there is no passive equivalent to Blended Emerging Market Debt creating fee pressure from below: the active management of Hard Currency versus Local Currency assets is central to the strategy.
Example: Multi-sector Fixed Income
The past four years have brought particularly significant movement in the pricing of multi-sector fixed income strategies. These feature a range of subtypes—some relatively conservative, others with a more high-yield orientation (see the recently published paper Multi-Sector Fixed Income: Back in Focus). As shown in Figure 8, median fees for ‘absolute return fixed income’ (a more conservative type) have declined from 48bps to 41bps (-15%), while the fee at the lower quartile has dropped from 40bps to 33bps (-18%).
Example: US vs. European Direct Lending
We have seen no evident downward trend in Direct Lending fees since 2017, reflecting a significant increase in demand for this asset class and the reduction in the number of managers. However, Europe still shows a wider dispersion of base fee offerings, which can be seen as somewhat characteristic of a less mature market: although the median fee quoted for an unlevered European direct lending strategy is very similar to that quoted for a US direct lending fund, the upper quartile is more than 20bps higher. In both markets, base fees are now almost universally charged only on invested capital (rather than on both invested and committed capital), helping investors to improve cost efficiency in this asset class.
Fee comparisons are complicated by the combination of leveraged and unleveraged fund offerings and the lack of standardisation in terms of the way that managers calculate performance fees. Nearly all managers seek to charge a performance fee, but hurdle rates range from 4% to 8% and performance fees range from 10% to 20%. Leveraged strategies typically reflect higher target returns with a higher hurdle rate, although the increase in hurdle may not always be sufficient to reflect the impact of the leverage. Comparing total fee leakage between different offerings requires a scenario-based approach: a ‘league table’ of managers sorted by cost ratio can reorder as the assumption about gross return changes.
Kathryn Saklatvala, Head of Investment Content at bfinance, said: “The fourth instalment of our investment manager fees series once again puts fee reductions in focus while honing in on some specific asset classes. In the light of investors’ growing interest in ESG and impact strategies, it is particularly interesting to see some very significant reductions in the fees that managers are quoting for clients. We will be keenly watching how pricing evolves for some of the more nascent sectors, such as Article 9 funds and Impact Real Estate, where there is more uncertainty around what an appropriate fee should look like.”