SAN FRANCISCO - In the confluent world of plan sponsors and investment managers, perception and reality don't always mesh.
In a recent survey, Callan Associates, San Francisco, found each side often views the same financial world from very different perspectives.
For example, the survey found pension executives "perceive the investment firms' pre-tax profit margins to be higher than that reported by managers."
Indeed, pension executives believed managers' pre-tax 1996 profit margins were in the 31% to 40% range; managers said those same margins were between 21% and 30%.
The survey also examined actual vs. published money management fees. It found "actual fees paid by plan sponsors are often less than investment manager published fees for most asset classes."
The degree of difference is influenced by four major factors, according to the survey:
An individual product's performance and risk characteristics;
The maturity of the product with respect to its historical use by institutional investors;
Marketplace supply and demand forces;
The length of the relationship between manager and client; and
The size of the individual mandate, with larger accounts receiving greater discounts.
"There are many variables that can help determine what the actual fee charged will be," said Ann De Luce, senior vice president at Callan.
"The type of portfolio is certainly a major factor that comes into play. Overall, I'd say that we found more differential in the fees charged for the more mature asset classes."
According to the Callan survey, negotiation is seen by most sponsors as a necessary means of attaining the best possible fee.
Pension executives negotiate fees with nearly three-quarters of their investment managers, Callan said. Public funds negotiate most often.
The survey also noted the increasing use of money managers for multiple asset classes. The most prevalent discounting practice for these "multimandate portfolios" was calculating individual product published fees and "applying a discount to the sum of all of the individual fees."
Two other surprising findings: the low importance placed by pension executives on manager fees, and the relative absence of performance fees.
Ms. De Luce said of the 12 issues in the manager evaluation process, fees ranked in the third quartile.
First, she said, was investment style and strategy.
As for performance fees, Ms. De Luce said: "Given the level of discussion that has been ongoing in this area, one might have expected performance fees to be more of a presence.
"It's difficult to be sure as to why this is the case, but it's possible that the difficulty in implementing performance fees has served to discourage their use.'
Despite the infrequent use of performance-based fees, the survey showed some common practices.
For example, while some plan sponsors "generously reward upside relative performance, many pay a minimum of passive fees for downside performance," the survey noted.
Asked to pinpoint their "biggest issue or concern" regarding fees, many plan sponsors noted four major areas:
Fees vs. returns;
Uniform fees across manager clients;
The impact of hidden fees; and
Fees covering market and/or manager return.
Conversely, when asked what concerned them the most about fees, investment managers cited:
Downward fee pressure on mature products;
The ability to negotiate fees vs. the size of the firm or product;
Increased manager costs; and
The impact of indexing in influencing fee negotiations.
Not all money managers consider fees a big deal.
"Fees haven't really tended to be a big issue for us," explained Jim Margard, chief equity strategist for Rainier Investment Management Inc., Seattle.
"Our fees are competitive, and over time we have been approached to negotiate fees . . . But recently we've been reluctant to do so because we're not really soliciting a great deal of new business right now . . .
"And as for performance fees, they're standard fare for hedge funds, but I'm not seeing a groundswell for their use. It's possible that clients and consultants have become alert to the potential for mismanagement of an account in a performance fee situation. Unless it's done carefully, a performance-based fee relationship is one where a manager is encouraged to take risks he would not normally take in order to outperform."
Philip Schettewi, managing partner of Boston-based Loomis, Sayles & Co., cited the sophistication of sponsors as one reason fees are a relatively minor factor in choosing a manager.
"The sophistication level of our clients is high enough to understand that there's a lot involved in managing an investment portfolio," he said.
"There's an infrastructure that's in place, professionals communicating performance and process to the client, and a lot of research behind the purchase and sale of every security.
"And, there's a cost of doing that."
Plan sponsors say investment experience is key to choosing a manager.
"Fees are important, yes, but if they're reasonable and you're getting competitive returns it shouldn't be an issue," explained Norm Benedict, deputy executive director of investment for the $19 billion Colorado Public Employees Retirement System, Denver.
"We use both fixed fees and performance-based fees and both are working well for us. But we also want accountability, because if you start abusing fees, then you're dead in the water."
Another investment officer echoed Mr. Benedict's sentiments.
"The fees charged come into it, but they're certainly not the overriding concern," explained the chief investment officer of a San-Francisco-based sponsor, who asked not to be identified.
"The experience and stability of the management team is vital. We don't consider anyone who hasn't been in the industry for at least five years. Also, if there's been a significant turnover at the management firm, that pretty much tosses them out. We also look at returns in a risk/return context."
He said performance fees mainly are used for "alternative investments, such as a hedge fund or venture capital. In those kinds of funds, you're taking the limitations off of the guy, essentially, based on the premise that he can kick butt."
More than 200 money managers and 87 plan sponsors - all with assets of more than $1 billion - responded to survey.
