The Added Pressure on Active Management Fees

The Added Pressure on Active Management Fees

A recent report produced by the Boston Consulting Group found that revenue and profits earned by asset management firms fell globally in 2016 for the first time since the 2008 financial crisis. The decline in revenue was despite an increase in assets under management due to rising markets, which grew 7% to $69 trillion. There was little change, however, in net new money. The advent of robo-advising has added additional pressure on active managers and the ability to construct investment portfolios for a reasonable fee.

Working in portfolio management, and part of actively managing portfolios, we see that clients are paying more attention to fees. Heightened awareness and ease of access to low-cost passive investments puts active managers in a tougher position. Active managers now must consider lowering fees, in addition to reducing expenses, to stay competitive. Another challenge is a shift in generational wealth from Baby Boomers to Generation Xers and Millennials. Currently, Baby Boomers hold 50% of all investment assets, while Gen Xers hold 8% and Millennials hold only 2%. The issue, which is essential to future growth, is determining how to attract these younger, tech savvy generations.

There has been research suggesting there are three factors that determine how much investors are willing to pay in fees for active management: the client’s appetite for risk, the difference in risk adjusted returns among assets, and the precision of security analysts. The last two factors really emphasize the quality of security analysis and selection, as well as the weighting or allocation within the portfolio.

While robo-advisors may have algorithms to run through these formulas, based on investor inputs to determine the appropriate asset allocation or optimal portfolio, it does leave out the human element. Active managers may have the ability to better understand a client’s concerns about portfolio construction and are able to discuss these concerns with them. Active managers who find ways to use robo-advisor software to lower costs while constructing portfolios made of their own security selections, as well as their tactical and strategic changes, will have an advantage.

Active managers must also be able to explain and defend the fee they charge over passive index investments and low-cost providers. One advantage to using an active manager is the individualized and personalized service clients can receive, knowing that there is someone watching over their portfolio at all times. Also, investing in a passive index will never yield outperformance. It will simply track that index, whereas active managers may beat the benchmark, although outperformance is never guaranteed. Another positive for active management is the reduced risk that can be gained by investing in alternative asset classes and strategies that are negatively correlated to traditional stocks and bonds. The broader diversification could provide better returns for the level of risk but is rarely available with a robo-advisor.

Fees are an important factor in determining long-term investment results; however, it is not the only factor. Investors who consider only past performance and fees may not attain the risk adjusted returns they could achieve. On the other hand, active managers who do not consider fees will not provide the best results either.

Content for this blog post provided by Derrick Wilson, Senior Portfolio Analyst.

 

Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.

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