Theres a free-for-all going on in the 130/30 market, as money managers offering the strategies are testing not only fee levels, but also different fee structures, to see what works.
Some managers are willing to be flexible and negotiate (fees), especially the ones with only proprietary capital in the fund, said Florian Weber, a Los Angeles-based research analyst in Wilshire Associates Inc.s manager research group.
Money managers predict big growth for these strategies, as pension funds continue to seek alpha-generating equity portfolios.
A recent survey of managers by Pensions & Investments showed assets in the so-called active-extension strategies grew 77% between the first and third quarter of this year, to more than $53 billion (P&I, Oct. 29).
The allure of 130/30 strategies is bringing everyone to the table quantitative and fundamental managers who managed long-only portfolios and want to add shorting capability, as well as hedge fund managers wanting to attract pension fund assets.
Each type of manager has a different expectation of what he or she can charge. And the race to grow assets is making managers more flexible in the way they charge fees.
At the end, its almost always negotiable, said Aaron Roberts, a vice president in the Florham Park, N.J., office of Callan Associates Inc. who advises money managers. Most managers said theyre almost always being priced at a discount to their published fee schedule Theyre trying to get their seed money out and client money in, so they are willing to negotiate the fees.
Officials at 11 of the 15 largest managers of 130/30 strategies said they allow clients to choose whether they want to pay a flat management fee or a performance-based fee. Among the four who do not: Acadian Asset Management Inc., Boston, offers only a performance-based fee; and Martingale Asset Management LP, Boston, offers only a flat fee. Executives at Barclays Global Investors NA, San Francisco, and DuPont Capital Management Corp., Wilmington, Del., declined to comment on their fee structures.
Consultants and prime brokers assisting fund executives with implementing 130/30 strategies said there is much more flexibility with the fee structure for these strategies than for any other investment product.
Writing on the wall
Money managers see the writing on the wall. Most of the money in these strategies will come from large pension funds. Many of those same funds have restrictions that keep them from investing in a strategy that has a limited number of assets.
The managers are pretty hungry to attract assets and are willing to be more flexible to get investors , Mr. Weber said. Most of these products have seed money of just $10 million. Thats not enough to be considered by the large institutional investors.
Money managers and consultants say hedge funds, which typically charge an asset-based fee plus a percentage of performance over a specified hurdle, are less likely to budge on fees for 130/30 strategies.
If youre approaching this from the hedge fund side, my guess is theyre going to be strict on fees. Theyre used to doing this on 2 and 20, said Edward Goldfarb, managing director of Numeric Investors LLC, Cambridge, Mass., which manages both traditional strategies and hedge funds. Numeric offers clients a choice between flat fees and performance-based fees for its 130/30 strategies, but Mr. Goldfarb would not provide details.
Mr. Goldfarb said executives at many hedge funds will not budge on fees for 130/30 strategies because they dont want to give up crucial capacity for a lower fee product.
So far, most assets allocated to active-extension strategies are going to traditional managers, a sign that clients might not be willing to pay hedge fund-like fees.
The 12 really large managers getting most of the assets are coming from the traditional side, said Sarah Barratt Ball, an executive director for Morgan Stanley Prime Brokerage, New York.
She said most of the 130/30 investors are paying asset-based fees.
Regina Gannon, a managing director who runs the client relationship management group for UBS Investment Bank, New York, estimates 70% of 130/30 managers use asset-based fees and 30% offer performance-based fees, although the latter is growing.
They are wanting to show investors their interests are aligned, she said. This is a stop along the way to offering more pure total-return, hedge fund-type products.
Prime brokers work with all of the money managers by providing securities to short and by lending money to make more long investments. While prime brokers said more institutional investors are choosing asset-based fees over performance-based fees, some managers disagreed.
Choosing performance fees
Mr. Goldfarb said most Numeric clients have chosen to pay the performance-based fee. He also said those fees are not as high as the 2% of assets and 20% of performance charged by some hedge funds.
Executives at State Street Global Advisors, Boston, and Aronson + Johnson + Ortiz LP, Philadelphia, also said most clients are choosing to a pay a performance-based fee. Their performance fees for 130/30s are also not at the level of hedge-fund fees.
Clients choosing performance-based fees at AJO, for instance, pay nothing for index-like returns, but pay 16 basis points for each percentage point of performance over a benchmark. That caps out if the strategy outperforms the benchmark by more than six percentage points.
The shorter your track record, the more inclined (clients) are to say Ill try this, but put your money where your mouth is, said Gina Moore, a principal and portfolio manager at AJO.
One consultant, who asked not to be named, said fee issues regarding 130/30 strategies are a long way from being settled.
The initial entrants tended to be the quants. Typically theyre charging a flat fee of roughly 60 to 70 basis points. Youre now seeing a second wave of traditional stock pickers getting in. They charge a flat fee and performance over a benchmark.
The question will be with hedge funds coming in, will they be able to charge hedge fund fees? So far, thats not been the case, the consultant said.