Index managers get revenue rush from alternatives

Three traditional index managers are finding a shift into more high-octane strategies is boosting their revenue. In some cases, the increase is more than 20%.

Officials at Barclays Global Investors Inc. and Mellon Capital Management Corp., both of San Francisco, as well as State Street Global Advisors, Boston, said growing interest by clients in overlays, long-short mandates and other alternative strategies is helping fuel revenue growth. These strategies command higher fees, frequently based on performance.

BGI, with $1.4 trillion in assets under management, reported a 23% jump in net fee and commission income in the first half of 2005 — the highest level the money manager has ever experienced. The spike was attributed to a sharp rise in management and incentive fees across all areas.

The company's exchange-traded fund family, marketed under the iShares brand, is the biggest contributor.

BGI is seeing a "real move by clients to look at more alternative strategies, and a continued transformation from index mandates to long-only or long-short strategies," said Matthew Scanlan, managing director and head of the Americas institutional business.

SSgA's investment management fees totaled $173 million in the quarter ended June 30, up 13% from $153 million a year earlier. Management fees reflect "continued new business and an increase in average month-end equity valuations," according to a news release. Total assets under management were $1.4 trillion as of June 30, up from $1.2 trillion a year earlier.

SSgA's development is "driven by our continued non-U.S. business growth, as well as the changing business mix demonstrated by more and more active and enhanced mandates," said Christopher Pope, SSgA's senior principal and director of institutional sales, client service and consultant relations.

The greatest increased use of performance fees occurred in SSgA's enhanced index and hedge fund lines of business, primarily market-neutral long-short, Mr. Pope said. In enhanced strategies, 50% of new SSgA clients are using performance fees.

"In many cases, they are reallocating away from a passive assignment as they do not want to pay additional fees unless we can deliver a commensurate excess return," he said. "In the hedge fund arena, all of our new clients have engaged us on a performance-fee basis."

Mellon Financial Corp., the Pittsburgh-based parent of Mellon Capital, recently reported that second-quarter investment management fees shot up 15% from last year to $437 million, thanks, in part, to improved market conditions and a higher level of performance fees.

Mellon Financial does not disclose details about its fee structure. Charles Jacklin, president of Mellon Capital, with $125.9 billion in assets under management, said most new clients use performance fees in overlay and absolute-return strategies.

"To the extent (clients) are looking for large amounts of alpha, they don't want to pay unless they see the alpha," Mr. Jacklin said.

Use of performance fees has waxed and waned over the years, depending on the market environment and managers' ability to deliver consistent excess returns. But the rise of hedge funds is helping advance the issue, said David Bauer, principal at Casey Quirk & Associates LLC, Darien, Conn. "Hedge funds, regardless of absolute fee levels, have put a stake in the ground saying, ‘We're willing to invest our money right alongside our clients,'" he said.

For some corporate pension executives, the move to performance-based fees is a Hobson's choice.

"We have been investing in overlay strategies and portable alpha, and because of our move to those type of strategies, we're conforming to these (performance-fee) structures," said Kimberly Walker, president of Qwest Asset Management Co., Denver, with $13.7 billion in assets.