Tiered pricing is being pushed as a fairer alternative to ad valorem fees for retail investors in light of the Woodford Equity Income wind down but commentators have quibbled whether there is incentive for active managers to change or if they would be able to cope with the added administrative burden.
CFA UK came out strongly in favour of tiered fees in its review of retail fund fees, which it launched in conjunction with the Financial Conduct Authority introduction on 30 September of assessment of value rules.
CFA UK weighed various fee structures against four principles – simplicity, transparency, aligning the interest of investors and managers and treating all investors fairly.
CFA UK professionalism adviser Andy Burton says the concept that the fee will drop as the fund grows in size is still relatively easy for investors to understand and would be simple to show in fund documentation.
The alignment of interest is also there, Burton says.
“With an ad valorem fee the fund manager gains all the upside of the fund growing whereas a tiered fee will allow investors to participate in that.
“And that participation is open to all investors so it’s fair to all and there’s no issues with people buying a fund and exiting a fund which is one of the complications with some of the performance fee structures we looked at.”
Asset managers have been able to charge a full fee without question
Both Fidelity and Allianz have rolled out variable performance fees on some of their most popular funds, while M&G Investments announced it would be trying a tiered structure on funds with over £1bn of assets.
But these firms are in the minority.
AJ Bell head of active portfolios Ryan Hughes says up until recently there hasn’t been any incentive for open-ended funds to switch up their approach and introduce a lower fee structure.
“I think it would be fairly clear that the reason they haven’t gone down the tiered approach is because they’ve been able to charge a full fee on all the assets without question for the full period of time,” says Hughes.
Burton notes tiered pricing is already mainstream practice in the US with over half of retail funds having tiered fees in place.
The most common way to recognise scale benefits are applied is at the individual fund level. Only 10% of asset managers apply tiers to the AUM of the entire fund range and an even smaller portion (3.7%) apply tiers to the total AUM of the firm itself.
In the UK, tiered fees have taken off in the investment trust universe.
Baillie Gifford has rolled out tiered pricing across several of its largest trusts, including the £7.8bn Scottish Mortgage, which charges investors an annual management fee of 0.30% per annum on the first £4bn of net AUM and 0.25% pa thereafter.
Vanguard is the superior model
CWC Research director Clive Waller says traditional performance pricing doesn’t work because fund groups have typically asked for too much money on the downside when they lose.
“In the case of performance fees, the market has judged that asset managers that go down that road keep too much when they don’t perform and get more for over-performance,” he says.
The Fidelity Special Situations fund, which was among the first of its funds to adopt the fulcrum fee, dropped its base fee from 75bps to 65bps. But it can charge as much as 85bps or as little as 45bps depending on whether the fund beats the FTSE All Share index by 2% or more on an annualised basis calculated over a rolling three-year period.
M&G’s funds were criticised for still being too expensive even after tiered charges were applied. Investors with £10,000 in Richard Woolnough’s M&G Optimal Income and M&G Corporate Bond fund would have benefited from a 7bps drop in the annual charge, saving them £7 a year, and would have saved £35 a year in the £2.1bn M&G Recovery fund.
The Vanguard model remains superior, Waller says. “They lower their charges the more money they run in total – for everyone.”
He points out that in the US Vanguard’s Personal Advisor Service costs 34 basis points for asset management, platform and advice. Comparable services in the UK run closer to 250bps on average, Waller reckons, though he admits it is difficult to get an accurate figure on this.
Tiered pricing hurts smaller portfolios
But GBI2 managing director Graham Bentley says it is easier for Vanguard to pass on economies of scale because it is “a less labour-intensive business” and is starting from a cheaper rate because it deals in passive products.
“If you have a massive marketshare you can afford to be magnanimous in terms of how you do your pricing”.
Whereas if you are a smaller fund group with only a few billion of assets under management this becomes much harder.
But Burton says in theory tiered pricing can work for smaller players.
“New funds and new firms need to be able to cover their costs and compete,” he says. “So how quickly do you scale down the fee as the fund grows in size? Do you perhaps charge an ad valorem fee initially, and then scale it down later?”
What’s the incentive?
One of the reasons tiered pricing hasn’t taken off in the retail space is because it would create a complex administrative issue for fund groups which typically have products with multiple share classes.
Compared with investment trust companies that have a smaller universe of suppliers the Oeics space is “a huge universe” with some 3,000 to 5,000 schemes.
Investment managers’ profit margins depend on business from advisers and fund selectors, not D2C or DIY investing, says Bentley. “And as long as those people are not saying, ‘Come on, what we want is a tiered rate,’ then there’s no motivation for companies to do that.
An alternative would be to have a separately managed account arrangement, Bentley says, “where there’s not necessarily share classes but a system that can recognise a holding by an individual and then a portion of an average fee”.
Bentley says there are active management houses big enough to use their economies of scale to make things cheaper for the end investor.
Those that are on the cusp of being bigger could potentially attract more flows if they became a first mover on price and actively campaigned to bring costs down while demonstrating how active managers are delivering value.
That said he doesn’t know whether there is a clear first mover’s advantage. “There’s always that old phrase that pioneers get scalped”.
Woodford saga could prompt rethink on tiered fees
Hughes thinks there is a possibility that the Woodford Equity Income saga may force Oeics to reform their fee structures, especially if more investors are drawn to investment trusts.
“I would certainly hope that out of all of the Woodford debacle becomes a greater focus on investment trusts as a vehicle that is suitable for, for many, many people and maybe that will be the pressure that finally forces the open-ended world to adopt what essentially is a fairer fee structure.”
Adopting a tiered structure might also be an important tool for active houses to compete with cheaper passive rivals.
“The FCA wants it; investors want it. It’s probably time for fund groups to start really listening.”
