Some institutional investors pay money managers as much as 400% more than others for the same active portfolio services and account size, a new study shows.
"There is simply no justification for many of these huge differentials," said Edward A.H. Siedle, president of Benchmark Financial Services Inc., Lighthouse Point, Fla., and author of the study. "Many funds are paying higher than necessary investment advisory fees. You can say pricing doesn't make any sense given norms in the area. There may be a story attached to the lowest fee arrangement and there certainly is a story attached to the highest fee arrangements."
The study analyzed the actively managed fees actually paid to external managers by 100 sponsors, each with at least $100 million in pension assets as of 2002. Of the sponsors, 59 are corporate, 22 are multiemployer and 19 are public. Twenty-five of the plans directly provided information for the study; fee data for the other plans came from ERISA-related filings.
600 separate fees
In all, the study collected data on more than 600 separate investment management fees paid by the sponsors.
Mr. Siedle plans to sell the study for $5,000, targeting sponsors, managers and consultants. He said the findings will help sponsors better negotiate with managers, while providing managers with a better rationale for setting fees. He intends to update and expand the database, depending on demand.
Among findings in the study: Active management fees rose 9% from 1992 to 2000, said Mr. Siedle. The "rise might be attributed, in part, to the combined forces of consultant conflicts of interest, plan sponsor inattention to fees and lack of adequate comparative fee information," according to the study. The investment advisory fees paid by pension funds "for actively managed accounts are generally high and have crept up over time," the study notes.
Also, corporate fees were almost 20% more than those of public pension funds, based on mean investment advisory fees paid to external managers, including equity and fixed income - both actively and passively managed.
"Public and union plans pay on average six basis points less than corporate sponsors for active management," the study found.
In the study, Mr. Siedle notes, "(T)here was no accepted methodology for assessing the reasonableness of fees paid by plan sponsors. Despite the obvious impact of fees upon plan returns, it appeared few serious fee studies had been undertaken. In support of this observation, we noted a dearth of information regarding `actual' fees, or the fees funds actually pay to managers." Consultants typically provide clients with published fees of managers, he noted.
Study nears completion
Independent Consultants Cooperative, a group of 16 consulting firms, and Deutsche Bank and its WM Co. unit, New York, are nearing completion of a study of the actual fees sponsors pay managers, said Howard H. Pohl, principal at Becker, Burke Associates Inc., Chicago, one of the members of the ICC. That study is using the data from its consulting firm members, representing $720 billion in assets, 1,000 money managers and 13,000 portfolios. He expects the study to be ready in about a month.
Mr. Pohl agrees there is no relationship between published fee schedules and the actual fees fund sponsors pay.
In the Benchmark study, Mr. Siedle writes the "prolonged bull market may have caused plan sponsors to be less concerned with fees and more focused upon performance. Our research indicated that plan sponsors until recently considered manager fees only of middling importance. While fees were of growing concern to funds, sponsors frequently did not negotiate fees with managers. Often `published' fees (or even higher-than-published fees) were accepted by funds without question. We discovered public funds were the primary negotiators of fees and paid substantially lower investment advisory fees than corporate plans, endowments and foundations - perhaps as a result of their negotiations. Surprisingly, a growing number of funds that retained managers to manage multiple accounts did not receive a discount."
But Samuel W. "Skip" Halpern, executive vice president and general counsel of Independent Fiduciary Services Inc., Washington, has a different view.
"From our perspective, fees tend to cluster pretty closely together," Mr. Halpern said. "But it is true there are outliers. You do get some very wide ranges." For example, "even with a single client we sometimes might have three managers of a given style; two might be very close in fees, while the third is off the charts," for similar portfolios.
Fees are routinely one of many important subjects in the firm's work for sponsors, he added. IFS performs operational reviews and retainer work for plan sponsors.
For one of the most popular asset classes, large-cap equities, the study found for portfolios of more than $150 million, fees ranged from 45 basis points in the 75th percentile to 22 basis points for the 25th percentile. The top fee for that category was 85 basis points, four times more than the lowest fee in the category, Mr. Siedle said. The median fee in the category was 27 basis points, while the mean fee was 34 basis points.
Mr. Siedle blames consultants for what he believes to be excessive fees. He suspects, in the study, "the lack of in-depth `actual' fee information might be due, in part, to conflicts of interest in the consulting industry. Consultants, eager to maintain favorable relations with money managers (to whom they also sell services) may not wish to alienate them by providing plan sponsors information that could be used to negotiate lower fees."
"Sponsors that rely upon investment consultants to recommend managers and negotiate fees need to be aware of the divergent business interests of consultants," which may conflict with the interests of sponsors and undermine negotiations with managers, the study says.
"Consultant conflicts, once identified, should either be eliminated or ameliorated at the outset."
"We believe investment managers should, therefore, explain their fees in terms of the resources they bring to the investment assignment and other `cost' factors, such as soft dollars and turnover, which are under their control," according to his report. "The expectation of future performance should not be an acceptable justification for excessive fees."