Fees and investors: A necessary talk

Once a money manager is hired, the firm — and its new client — rarely revisit the topic of fees. This harms not only the asset owner, but also, potentially, the manager.

Earlier this year, Chestnut Advisory Group interviewed more than 70 asset allocators — all chief investment officers — by phone. We asked them how informed they are about the fees they pay asset managers and what role, if any, fees play in their decision-making process.

We found that, once hired, asset managers go silent on fees; most investors also lose focus on this important topic — to the point that many investors with whom we spoke weren't even sure what their general fee level or structure was for most of their managers. This ignorance about the fees investors pay is compounded by the fact most asset managers do not regularly talk about fees with their clients once hired, leaving the asset manager vulnerable to a misunderstanding that can lead to termination.

While this reticence to directly address such a hot topic is emotionally understandable, from a business point of view it leaves the asset manager vulnerable. Without guidance, an investor can start looking into fees in a light that may make an asset manager look bad. This lack of communication also leaves the investor vulnerable to a sudden scramble for information.

It's up to each asset manager to explain its value proposition to investors. We recommend asset managers have this discussion at least once a year with each client.

In the void left by that asset manager silence, investors are coming to their own conclusions about the value proposition they are receiving from their asset managers.

For instance, investors are ambivalent about the efficacy of the performance fees they pay. Although 69% of respondents believe their asset managers that are receiving performance fees outperform those that don't, almost half of all respondents also believe those managers are taking excess risk to deliver performance that triggers those fees. This is exactly the type of potentially dangerous perception that an active dialogue between the asset manager and the investor can address.

Because asset managers often agree to discount their base fee by negotiating an offsetting performance fee, we asked investors whether they believe they end up paying less all-in with the two-fee system. The results were evenly split, with about half saying the two-fee structure saved them money, and half saying it didn't. This type of situation is a prime opportunity for the asset manager to circle back to their client and explain how the fee arrangement has served the client's interest by collectively aligning both the client and the manager's interests, while saving fees during periods of underperformance.

Hardly anyone we surveyed claims fees are the most important variable when hiring an asset manager. Only 42% of all respondents placed fees among the top three factors in manager selection. Twenty percent put fees even further down the list — at the level of a second-tier consideration. Among all respondents, only a quarter said they take fees into account at all during the initial screening process.

Among the different types of investors with whom we spoke, defined contribution plan sponsors are by far the most price sensitive. Two-thirds of DC plan respondents rank price as a top-three factor in their hiring decisions. Given the visibility of fees in that space, this answer makes sense. DC plan executives also bring fees into the equation earlier than other executives, with 73% focusing on pricing during their initial screen or the initial interview process, vs. an industry average of slightly less than half.

The most consistent fee negotiators are government plans and the largest funds. Asked how often fees are negotiated when hiring a new manager, 50% of government funds and 48% of the larger funds (more than $5 billion) said “always.” One government fund executive told us: “We're (one of the largest funds) in the U.S., so we throw our weight around.”

The ability to negotiate fees seems, not surprisingly, plan-size dependent, with smaller plans negotiating far less frequently — only 13% of funds with less than $1 billion said they "always" negotiate. As most-favored-nation clauses have become more widespread, investors feel less pressure to pursue the best individual deal.

Investors that negotiate are getting increasingly savvy, playing large asset managers with multiple product offerings against each other to help investors get the fees they want. As one corporate DC plan executive said: "I have found that you need to be more proactive on this front to ensure they (the asset managers) retain the business they already have with us."

Still, not everyone negotiates. Almost a quarter of respondents say they "virtually never" negotiate on fees. Endowments and foundations are the least likely to negotiate, followed by family offices. As these types of investors generally manage smaller funds, this result is not surprising.

We recommend asset managers address fees with investors head-on.

Have an annual discussion about your value proposition with every client. Once a manager has been hired, most investors quickly forget everything about the fee structure, a situation that leaves the asset manager vulnerable. Managers that foster a good understanding of the full value proposition they deliver to their clients will stand out positively against their peers. An informed client is much more likely to remain a long-term client.

We recommend the following be part of your conversation:

• Remind investors the role your product plays in their portfolio. Provide data to support that you're doing what they hired you to do, such as current income, portfolio diversification or low volatility.


• Compile all the client-service elements you've provided over the past 12 months, such as board presentations, portfolio manager calls and meetings, in-person meetings, requests for information, or site visits.


• Remind the investor who is on your team to provide client service. Include in this names, number of people and experience.
• Compare what the client is now paying to a flat-fee structure, especially if you negotiated a base fee plus performance fee structure.


• Ask your client what else you can be doing to meet their needs.

Amanda Tepper is founder and CEO of Chestnut Advisory Group, Westport, Conn., an investor relations consultant firm to asset managers. This article represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.