Like active managers searching for superior companies with skilful management, it is our business to find superior funds managed by skilful investors.
However, unlike managers and stocks, we often find an issue with regard to the ‘value proposition’ - how much excess value they expect to add versus their fee.
For example, we could find an active manager who has delivered strong long-term results, backed by an exceptional approach and tested over a long period. But we may also evaluate a manager with no obvious active investment skill or a fund that has changed managers a few times.
Quite perplexingly, the fees on these two funds might be exactly the same.
So what is going on? There are a few factors – some highlighted in the FCA’s report which clearly stated the lack of price competition in the industry – but we also suspect strong ties to the concept of value proposition, or the lack thereof.
In our experience, many managers are not clear on their value proposition, and this encourages fee standardisation.
Paying a higher fee for more added value is not the norm and it feels like good active management is priced like a commodity.
We think, as active managers do, that they are in business because they believe they are above average, and can demonstrate skills to charge a higher fee.
But some active managers are also more skilful than others, and so these should demand an even higher fee for a higher quality offering.
So you would expect defining value add would be core, as those who can evidence real skill and, therefore, value add, should quite rightly demand a fee premium.
We ask questions on added value and skilful outcomes in our fund manager meetings: Can they define it, even in principle? And if so, is the fee they charge commensurate with the potential added value? Can they, perhaps, explain what a zero-skill outcome may look like?
These are clearly quite hard and subjective questions, but they require an answer if an active fee is being charged and, more importantly, if what they offer is genuinely valuable.
What sorts of answers do we get to these questions? They are usually quite vague. In part, this is justified because it is very hard to establish what excess returns look like with foresight.
But it is also something that is not deeply considered. For example, the days of saying a fund objective is “to achieve capital growth” should be numbered. It is undifferentiated and says nothing about the fund’s raison d’être – adding excess risk-adjusted returns.
So we can see how clients may well view active management as a commodity. And this is a real shame. As we find more pressure on active managers to lower fees, our sense is that it should not be a blanket cut. Some active managers are exceptional and should be able to hold their line on fees. But, others, who have a poorer value proposition or ones with lower excess return expectations, should face fee pressure.
It is our hope that the downward fee pressure on active managers is not indiscriminate. But we fear it might be.
Rory Maguire is managing director at Fundhouse
