Report examines secular trends driving fee compression, as well as pricing strategies used to combat it
The continuing trend of fee compression in the investment fund industry has long been blamed mainly on the rise of index investing. But according to a new report from Cerulli Associates, there are other secular trends at play, which asset managers must counter with innovation.
While a lot of the attention around investment-fund fee compression has centred on active managers, Cerulli noted that indexers have also been sideswiped by the trend. “More broadly, investors of all sizes simply want lower-cost investments and they are willing to access them through a variety of means,” it said in a new report.
Among the central factors driving ongoing fee compression, it said, is the heightened buying power investors now wield thanks to increased intermediation. With influence being consolidated at specific points within both retail and institutional sales channels, both advisors and institutions have been able to aggressively pursue pricing concessions from asset managers.
And aside from lower-cost investment structures, the report said retail and institutional buyers are able to access databases of fee information, giving them even more power of choice.
“Another chief reason behind fee compression is increasing commoditization,” the report said, noting heightened competition that comes from potential substitutes for active strategies as managers aggressively price similar strategies. “[T]here is more of a focus on using active and index strategies as complements to building lower-cost portfolios.”
In recent years, Cerulli said, it has seen asset-weighted management fees decline across both mutual funds and ETFs. It said from 2015 to 2019, the asset-weighted average management fees for institutional mutual fund shares have declined from 49.3 basis points to 45 basis points. Over the same period, the average asset-weighted fee for all ETF strategies declined from 25 basis points to 18.8 basis points.
As managers whose shingles have been hung on active management struggle with retaining and growing market share, the report said they have strived to be price-competitive by targeting fees that are at least below median levels. To achieve that, many have taken to implementing fee waivers or cuts to their management fees, while others “are taking the scalpel to fees charged by service providers.”
The report also highlighted the role of fee innovation, with some firms adopting wholesale structural changes to their compensation as others opt to tweak eligibility requirements for certain client segments to get lower-cost access to their investment strategies.
“One of the most common ways managers pursue fee innovation is through share class expansion,” the report said, noting a growing trend of asset managers opening institutional share classes up for retail investors. “A catalyst for this has been more advisors moving into fee-based advisory programs.”
Another avenue of innovation in recent years, it said, was the introduction of retail versions of performance fees – specifically fulcrum fees, which rise or fall depending on performance versus a benchmark. It also highlighted ongoing vehicle proliferation, with certain existing strategies being deployed through wrappers like ETFs or separately managed accounts that allow some combination of cost savings or greater pricing flexibility.
But as firms modify their fee structures and enact price reductions, Cerulli warned that they should ensure consistency across their product line-ups. For instance, asset managers that seek to replicate existing strategies into ETFs should have symmetric fees to avoid conflicts of interest for clients.
“Broker/dealers (B/Ds) have been particularly vocal in their desire to avoid the same strategy in a mutual fund and ETF that are priced differently,” the report said.