Will investors finally say ‘enough is enough’?
IN A RECENT Financial Analyst Jour-nal article on “The future of invest-ment management”, Gary Brinson made the following observation: It’s only a matter of time before investors would revolt against the current lev-els of asset management fees being charged in the industry.
As he pointed out: “One need only measure the aggregate fees that are paid by investors with the aggregate value added by their managers to see that something is amiss... because investing is effectively a zero sum game, aggre-gate fees for most managers should be associated with passive management. Yet these fees are significantly larger than fees associated with passive man-agement. This illogical conundrum will ultimately have to end.”1Nobody disputes that asset manag-ers need to be paid for their services. The debate, rather, is over what quan-tum is fair.
How do you approach the problem of ‘fair’? One thing that’s clear is that nobody has developed a single model approach to addressing the problem. What follows is a description of three methodologies: each has important limitations but, all told, do advance our understanding of the problem.
The first addresses the question posed by Brinson. Can the performance contributions of asset managers really justify the fees charged? The other two assessment approaches address the question of “did I pay too much?” given what was delivered.
The Ennis plausibility model
Let’s start by turning the question around. Just how much skill does an asset manager have to have to jus-tify the kinds of fees currently being charged? Richard Ennis2 provides an excellent methodology for determining that.
The Ennis plausibility model is pred-icated on the insight that the more expensive a product, the harder it is to deliver a product that will satisfy an investor’s expectations. Fees are only be plausible if they are consistent with an acceptable probability of success.
We then translated Ennis’s research into a tool that’s flexible enough to test the reasonability of fees with different skills levels and different acceptable levels of success.
As can be seen in the table, to main-tain the same level of investor suc-cess probability, the higher the fee charged for a prod-uct, the higher the fund manager skill required to justify the higher fee.