Does the saying ‘you get what you pay for’ hold true when it comes to paying for professional investment management? Jarrod Brown, CEO of Bennelong Funds Management, largely agrees. As the fee debate gathers momentum, he shares his views on the value of active alpha generation, why investors should focus on the broader investment picture and how Bennelong validates its investment management worth.
Performance fees, charged to investors when investment professionals exceed specific performance hurdles, are growing in presence among Australian fund managers. Although far from new, charging for outperformance has received considerable focus recently due to weaker equity markets, the resulting flight to lower-risk and passive investments, and regulators’ ongoing discussions about performance fee standards in the context of FOFA and MySuper reforms. The knock-on effect is investors – those actually paying the fees – are questioning the price for alpha/outperformance. Not surprisingly, they may be losing sight of the relationship between price and the generation of value. But at what cost?
Performance fees aim to align investor and fund manager interests. According to Lonsec, “performance fees change the incentive structure for a fund manager to make it congruent with the interests of investors by aligning the fund manager’s fee-earning potential with the performance outcomes for investors.” Moreover, having a performance fee structure in place can also reduce a manager’s motivation to gather assets to maximise revenue at the possible expense of alpha.
In theory, this is a mutually beneficial scenario. However, with no industry standards on how performance fee structures are displayed and with high watermarks, hurdles and benchmarks often mentioned in financial media, it’s little wonder investors can find it difficult to compare the fees of actively managed products, let alone understand just what it is they’re paying for. With price an important factor when making purchase decisions, performance fees, despite their intended purpose, may sometimes deter investors from potentially alpha-generating opportunities.
Beta-driven products such as index and exchange-traded funds are generally cheaper than their actively managed counterparts. This pricing differential can sometimes cloud investors’ judgment when considering paying for active investment management. So, is this a case of investors not being able to see the wood for the trees?
When weighing-up paying for active management, it’s important investors consider the relationship between fees and the potential for superior investment outcomes. With exceptional investment management talent in short supply, it’s in the long-term financial interests of investors for fund managers to attract, retain and develop that talent. Naturally, this comes at a cost.
Similarly, managing a constrained pool of money rather than accumulating assets to the potential detriment of generating alpha, also has a price. Beyond these fundamentals, investors should also consider the robustness of the business, the manager’s investment philosophy and strategy, as well as the history of the fund and its managers, before investing their money.
Focusing purely on price does not allow for a balanced or comprehensive analysis. What investors must acknowledge is that accessing quality investment teams that have the potential to produce superior investment outcomes and whose practices foster sustainable alpha, costs more than buying passively managed alternatives that offer, at best, market returns.
Getting what you pay for
As management fees compress within the industry, we’re seeing an increasing number of fund managers charging performance fees as alignment between investors’ and managers’ interests grows. I believe this trend is likely to continue. Providing an appropriate connection between interests, performance fees not only promote mutually beneficial practices but encourage enduring partnerships that aim to control costs and deliver sustainable alpha.
At Bennelong, we aim to deliver superior investment outcomes by preserving capacity and working with the best industry talent. By protecting our portfolio sizes, we believe we can add greater value. By attracting, retaining and developing our investment managers, we believe we offer greater opportunity for quality investment returns. These practices and capabilities, however, cost money. As we’re not relying on luck to generate outperformance nor accumulating assets just to increase revenue, the processes involved to deliver alpha are multi-faceted and unique. So, as price can often denote quality, in the case of investment management, ultimately I believe investors get what they pay for.