Active asset managers will have to reassess the way they charge fees if they are to survive competition with passive and alternative funds, an investment conference heard.
This was the view expressed by Peter Kraus, chairman and CEO of US-based active manager Aperture Investors, who was speaking about the future of asset management at the European Investor Summit held by Societe Generale at its Paris headquarters.
Passive funds’ and alternative funds’ share of assets under management have increased over recent years at the expense of actively managed traditional funds – from 21% of global assets under management in 2005 to 40% in 2021. And allocations to active managers will continue to go down until there is more alignment between returns and fees, said Kraus.
“I believe the movement to passive must continue, and it will be hard for active managers to reverse this trend until fees are in line with much smaller returns,” said Kraus.
However, the passive and alternatives sectors will also face challenges over the next decade, said Krauss, as single hedge funds struggle to grow, the rise of private equity funds slows and private debt becomes impacted by a refinancing cycle – the first one since the rise of this asset class.
Within the passive space, there will likely be consolidation as larger firms look to use scale to squeeze out smaller players and build strength in brand recognition, distribution prowess and client service.
Nevertheless, active asset managers will see the migration of assets continue unless they address issues within their business model and the use of incentives, said Krauss.
Many turn to fixed fees
Asset allocators have a role to play here, said Kraus. Many allocators have focused on limiting fixed fees because these are measurable – but the net result is that fund managers gather more assets to achieve economies of scale, and this is not in the investors’ interest, said Krauss
“I’ve yet to see a strategy where returns do not deteriorate when assets grow. And at the same time, allocators view small funds with great returns as having ‘unsustainable alpha’ but then think this phenomenon goes away when a fund develops scale,” he said.
The nuances and complexities of performance fees mean that many turn to fixed fees instead. Fixed fees are simple, clear and easy to apply, but that doesn’t mean they are the right answer, said Krauss.
“Thoughtfully structured performance fees create the conditions for investors to achieve optimal excess returns, control excess risk-taking, attract top talent and minimise the incentive to gather assets to offset declining performance.”
Allocators will also have to accept that more of their capital will be passive, and if they want to achieve returns in excess of indices, they must be willing to allocate to active managers that are capacity-constrained and whose returns are primarily driven by financial incentives.
While Krauss concedes that not all of his predictions will come true, he urged the audience not to ignore the points he raised. “Disregarding these themes and eschewing change will result in sub-optimal returns and disappointment. Paying attention to the market’s incentives scheme to drive better behaviour over time will produce better returns for the industry, its customers and participants.”
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