Why fund management fees must tally with performance
There is need for asset managers in Kenya to change their view of the market in which they are operating from charging alpha fees for beta performance. FILE PHOTO | NMG
Here are the three important things that investors must demand from those overseeing their stakes.
When student-led “Fees Must Fall” protests erupted in South Africa, they quickly brought to the surface other hot button issues - class inequalities, lack of funding opportunities and the increasing odds facing the graduating black South African.
Throughout the campaign, however, focus was never lost on what the fundamental issue was: School fees were too high and they had to fall. Period.
Similar protests have been occurring elsewhere; inside the global asset management industry. Among other reasons, poor active performance (measured against respective indexes), emergence of index funds and the demand for more efficient returns are some of the key reasons behind this movement.
Unfortunately, this wave of change has yet to catch on locally. Today, I will look at the same subject but from a different standpoint; the alpha deception.
While many are aware of the prominent argument demanding lower fees - most active fund managers don’t beat the market – few are aware of another important reason; persistent beta-like performance; industry speak for similar portfolio performance as the benchmark index.
And looking through performance sheets of some of the local mutual funds, there’s plenty of this; more index-like returns that are less differentiated.
Even those that do beat the index rarely have they kept that momentum for a considerable length of time.
To be clear, nothing wrong with neutral returns but what’s unacceptable is charging alpha fees for beta-like performance.
This is outright deception. It’s not right for asset owners to part with 2-3 per cent annually (building on top of two per cent entry fees) just for market exposure. If its beta, then it should be (really) cheap.
But let’s try to understand the other side. Asset managers hold the belief that a frontier market such as Kenya should be an alpha utopia.
They believe market inefficiencies are rife and are to be exploited for some profit. Arid liquidity, poor corporate governance and an unpredictable operating environment are some of the factors touted as inefficiency drivers.
But does alpha live here? I don’t know. But if yes, then blame the manager for lacking talent to extract it.
If not, then blame theorists for fooling us to believe in the concept. Be that as it may, the status quo is indefensible. Most active managers are sub-standard. And global investors have already seen the light. They’re voting with their feet. The biggest asset managers are now index fund houses.
In the future, this is what local asset owners need to do. Make three demands. First, call for dis-aggregation of return profiles. Separate alpha from beta and only pay high for the former.
Second, demand index funds - indexing is an efficient way to getting exposures.
Third, demand a shift to illiquids – real state, private equity, venture capital et cetera – where alpha is still alive and can be easily be found.
It’s a new world. Portfolio managers should know that they too are “fungible”. Hiding behind high-sounding concepts such as alpha generation won’t work.
It’s time we let them know this time we’re watching. If it’s beta, it’s not unique. If its beta, it should be cheap. If it’s beta, then fees must fall.
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Note: The results are not exact but very close to the actual.
