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Study slams absolute return bond fund 'pricing shambles'

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Study slams absolute return bond fund 'pricing shambles'

Pricing in the absolute return fixed income sector has been labelled a 'shambles' by a major, detailed study on fund fees.

The global report, compiled by consultancy bfinance and titled Investment Management Fees: New Savings, New Challenges, highlighted the surge in demand for unconstrained bond funds in recent years, against a backdrop of historically low bond yields and ultra-low interest rates. 

bfinance said it frequently received enquiries from investors on what fees are 'fair' in this fledgling and diverse market, which encompasses a wide range of  strategies, including long-short, derivatives-light and derivatives-heavy, Ucits and non-Ucits, EMD-dominated
and EMD-light. 

It found that on average benchmark-agnostic fixed income strategies fees stand at 48 basis points, considerably more expensive than 'less trendy' Global Aggregate peer funds.

While risk levels vary considerably, bfinance found virtually no relationship between fees and volatility in absolute return bond funds.  

'Upon examining portfolio composition, we could discover no link between fees and the amount of corporate debt, high yield debt or even structured credit in portfolios,' bfinance said. 

'We also could not identify any patterns linking pricing with particular factor exposures.' 

The absence of a clear risk/reward linkage, poses the question of how fees are determined, bfinance commented. 

'Are managers maximising the opportunity to launch a more expensive product based on a relatively opaque alpha-generation process and little previous fee level discovery?' 

Active fund fees show 'remarkable resilience' 

The 15-page study also found that active global equity management fees had dropped by 8% in recent years. Lower-volatility active management fees are down 25%, while smart beta are 24% lower. 

Competitive pressures on active managers have been intense, while allocations to passive management and smart beta have soared.

According to bfinance data, average fees quoted by global equity managers have decreased from 62bps at the start of 2010 to 57 bps. 

This could be viewed as 'remarkable resiliance' considering the fee pressure in the industry, bfinance noted. 

One reason for this, bfinance suggested, is the 'inclination of managers to cluster around known average fees. It believes transparency may facilitate this effect, 'mitigating over-pricing but removing the
incentive for under-pricing'. 

Another antidote to compression is the tendency to position active offerings as complementary to systematic strategies rather than competitive.

'Managers have focused on metrics such as idiosyncratic (non-factor) risk exposure and active share, to distinguish themselves from smart beta and market cap indices respectively,' bfinance explained.

'More are providing unconstrained (as opposed to benchmark-relative) strategies.' 

In simple terms, clients have clamoured for real active managers and fund firms have marketed themselves accordingly, bfinance concluded. 

Meanwhile factor-orientated sub-sectors with the active manager universe show more extreme price reductions, with fees here falling by 25% since 2010. 

It is also possible to negotiate discounts from providers, with the average discount from bfinances active equity searches since January 2013 standing at 12%.

Smart beta  

Fee reductions in other areas have also come down markedly, with smart beta down 25% since 2011.

In a 2016 white paper, bfinance found alternative beta fees ranged from 30-150bps and a median of 74-80. This has now fallen to a range of 35-103bps and a median of 68.

'Much of this reduction can be attributed to the involvement of new providers, who are offering what tends to be quite competitive pricing as well as early bird discounts of up to 50%,' bfinance said.  

Fund of hedge fund funds (FOHF) have also cut fees dramatically in a bid to recover lost ground.  

The median quoted fee has dropped from 100bps to 80bps since the previous bfinance fee study in January 2015. In Europe, where investors fell out of love with the sector earlier than their counterparts elsewhere, the average is now down to 69bps.

bfinance underlined how difficult the climate has become for FOHFs following the financial crisis. 

'[The challenge] has been made more complicated by the evolution of alternative beta and the growing popularity of various multi asset or diversified growth strategies.'

However, fees have remained high in private markets, particularly in infrastructure and private equity, where the situation has worsened in some cases, 'with too much money chasing the available supply of opportunity'. 

Three takeaways 

The bfinance review is timely following the FCA's scathing review of active fund pricing in its recent asset management study. 

The researchers highlighted three takeaways from their study. 'Renegotiate, reassess and reprioritise, where significant price reductions have taken place, now may be the time to bring providers back to the negotiating table and get fees in line with new practices.'

Ultimately there are three fee-pressuring trends that have been bearing down on fund managers; a climate of mistrust following the global financial crisis, greater understanding of various betas dressed as alpha and a low-rate climate. These has made every basis point worth fighting for, bfinance said. 

The report's author, Kathryn Saklatvala, said: 'There are fascinating trends going on, particularly in global equity where active management fees have been surprisingly resilient in the face of intense competition from smart beta and passive funds.

'Yet there’s a clear bifurcation, with cost reductions in products with strong factor exposures, such as low volatility active management.' 

However, bfinance chief executive David Vafai pointed out fee visibility can be a 'double-edged sword', noting that while benchmarking can help ensure investors do not over-pay, it may also make managers less likely to offer prices significantly below the average.' 

'It is important to remember that fees and costs, although they are the focus of this study, are never the most important metrics,' Vafai said. 

'Although we point to sectors where significant fee reductions have taken place, and encourage investors to take advantage of them, we certainly do not seek to advocate cost reduction for its own sake.

'Value for money is the most important priority and we appreciate that more robust and diversified portfolios may deliver higher net performance despite greater expense.'    

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