Consultants are recommending that small funds hit harder at the negotiating table so that money managers don’t bleed them. Even though funds with less than $1 billion in assets may not appear to have much clout when going fist-to-fist with money managers, it’s possible to achieve lower fees if investment staff and consultants take on a good fight, said Rhett Humphreys, a partner at NEPC. “If you don’t knock on the door, it’s not going to open. It doesn’t matter if it’s a small or large account: Shame on us if we don’t try,” he asserted.
Approaches that consultants are using to secure more attractive asset management fees are to tap emerging managers, which are known for flexibility around fees, or ask for performance-based fees. This would tend to give the funds more bargaining power where they have traditionally been disadvantaged, as smaller mandates are seen as undeserving of fee breaks.
“There are economies of scale in this business,” said Jody MacIntosh, v.p. at CEM Benchmarking, an Ontario-based data provider that compares plan sponsors’ costs and returns. Drawing from data on 331 plan sponsors ranging from $36 million to $225.6 billion in size, CEM found that for every tenfold drop in a fund’s size, there is a 17 basis point reduction in net value added—a measure of a fund’s actual returns minus what it would have returned if it were invested passively in its long-term policy asset mix, less the costs of investing. For example, the net value added for a $1 billion fund would be 17 basis points higher than for a $100 million fund. “In general, funds under $500 million are not going to be as cost-effective as $40 billion funds,” MacIntosh said.
Size Matters
Size is a limiting factor, though there are ways to work around it, consultants say. According NEPC’s Humphreys, “If you can move to a separate account, you always have the right to negotiate fees.” Multi-billion dollar pension funds can secure separate accounts because larger mandates and total fees to the managers make the extra work needed to run one worth the effort, he said, adding that smaller mandates often wind up being pooled with other clients and are given less room to bargain on price. Amongst these pooled vehicles, a mutual fund doesn’t offer room for negotiation, but a commingled trust may offer some, he said. NEPC has one of the largest client bases of institutional funds with less than $500 million in assets.
“The tiered structure that asset managers use to calculate fees leaves small funds little wiggle room,” Eileen Neill, managing director at Wilshire Associates, concurred. A hypothetical growth manager might charge 1% of on the first $5 million invested, 70 basis points for the next $20 million, 50 basis points on the next $100 million, leaving smaller funds with less leverage, she said. Figures from data provider eVestment Alliance show that the larger the size of the mandate, the less U.S. fund managers pocketed as a percentage of investment’s size. One way small funds get around this quandary is by asking to pay managers based on performance and not mandate size, Neill says, adding that she is a fan of this approach. Smaller and emerging managers are also more amenable to negotiation, as they may not have much bargaining power either, said Neill. The risk, however, is that these managers may have ....