Here’s an original idea. As a fund gathers more assets under management, its managers should either consider reducing the management charge for those investors who helped the fund out at the beginning or reduce fees for all as the fund moves past key assets under management milestones.
This isn’t a wild, madman idea. Over in the investment trust sector, a number of asset managers have reduced fees as the fund scales up, most notably Scottish Mortgage (SMT), run by Baillie Gifford. One might conjecture that the existence of an independent board of active non-execs was one force behind this curtailing of fees.
The other model I suggested is less common but there are some new funds playing around the idea. In a few weeks’ time in this column, I’ll talk technology with a number of fund managers but one of the most interesting is an experienced investor called William De Gale, who used to run big mandates at BlackRock. He’s now running his own tech fund via BlueBox and he’s instituted the reduced fee idea for founder investors.
It’s not uncommon for new funds to offer a founder class of shares with reduced fees. In the case of BlueBox, fees on the founder shares reduce as the fund grows, hopefully all the way down to zero if the fund hits a big number.
The tyranny of the fixed percentage fee
I labour these mechanisms for reducing cost because it seems to me that the modern retail investor using funds (and platforms that provide access to them) is now the victim of a new tyranny, the tyranny of the fixed percentage management fee.
You may have noticed that asset management is a very profitable business. Anecdotally I get the sense that many a young ambitious young man or woman who would once have wanted to go into investment banking or hedge funds is now targeting good old fashioned asset management.
The old adage is that asset management is increasingly a winner-takes-all affair, with the most successful alpha seeking managers on tens of millions of pounds.
But I think it more accurate to say that asset management is also a scale business. As funds under management grow, so does the percentage charge. In the institutional space, big buyers with sharp elbows push back, forcing the fund managers to progressively cut back their fee as assets rise.
This makes institutional fund management increasingly a lower margin, larger scale business. Retail fund management, by contrast, is much more profitable because the fund manager can keep charging the same percentage fee, even as the fund grows beyond £100 million, then £1 billion.
It could be argued this is the just reward for scaling up a successful fund but it strikes me as rent-seeking behaviour that is entirely unjustified and a practice that wouldn’t be tolerated by most big pension funds.
Assume a 1% management fee for a £100m fund – that equates to a £1 million fee. If the fund hits £1 billion, that fee is now £10m. But is the fund manager really spending 10 times the amount of time, effort, money and blood, sweat and tears on the same fund? Of course not. The money drops to the bottom line in profit and huge bonuses for the fund manager. The right thing is to reduce the fee as the fund grows, and aggressively so. If a fund charges 1% just to break even at £100 million, why can’t it charge, say 0.40%, at £1 billion?
Who is fighting for private investors?
The reason this doesn’t happen of course is that unlike institutional investors, there is no big lobby for reducing management fees amongst the disparate world of private investors. Non-executive directors in most Ucits, non-listed funds are fairly toothless and disinclined to fight the retail investor's corner.
Fund platforms do a better job and the last few years has seen the emergence of funds with much more competitive fees, but they very rarely, if ever, decrease as the size of the fund increases. Occasionally fund managers willing to cut a commercial deal with platforms will offer specially reduced rates, but these are the exception rather than the rule.
Cynically, one might wonder if this is because many investment platforms also benefit from the tyranny of the percentage charge. Why is it that Hargreaves Lansdown charges 0.45% for fees under its control, or AJ Bell 0.25% for that matter? Yes, both platforms offer a lower rate once clients invest more than £250,000, but that threshold is set too high.
If we assume say £10,000 in one Hargreaves Lansdown plan (fees £45), and £200,000 in another (fees £900), does it really require twenty times the work for managing the latter account? I think not.
Platforms might, of course, invoke the defence of the commons – the wealthier clients subsidise the more marginal poorer clients. That argument has some merit of course and a simple flat fee in pounds, shillings and pence might put off smaller savers. But why couldn’t platforms’ tapered charging systems drop off more sharply, and kick in at a lower level?
In my experience it’s still the poor old middle class, middle aged, middle wealth pot clients who get squeezed hardest. Institutional clients wouldn’t put up with this tyranny of the fixed percentage management fee, so why should we?