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ARP Observations

Change is coming

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See all articlesThe Absolute Return Letter

The self-styled "merger of equals" between UK based asset manager Henderson and US based Janus Capital (due to complete in the first half of 2017) is all about scale and reach. In greater part this has been brought about through the need to drive costs down in a low growth and return world as exemplified through the rise of so-called passive funds.

It is, after all, the net return after fees that matter. Fund managers are going to struggle to perform sudden miracles and deliver outsized returns in the prevailing low return environment. So, it is fees that make a significant difference to the bottom line.

When investing, it is worth asking first whether you are looking to generate beta (the market return) or alpha (the deviation from that market return – positive …or negative)? Many will probably say they aim for both but, more often than not, better results are usually achieved when investors separate the two sources of return and let the overall objective (alpha or beta) drive the portfolio construction process.

If you primarily aim for beta, in a low return environment, fees charged by the vast majority of active investment managers are way too high, and you should not hesitate to switch to a passive investment strategy, which will cost you a fraction and, on average, deliver better returns (as the average alpha after fees is negative).

There are plenty of so-called active managers who will say that they are certainly capable of generating both beta and some alpha on top, but if they are that good, why, (at the risk of encouraging past performance to be a guide to future performance) haven’t many done so consistently?  Of course there are exceptions but, in reality, there are fewer active equity managers who consistently generate a meaningful amount of positive alpha after fees than those that don't.

Whilst there is always a place for active asset managers, it is lower fees that will determine those that have a part to play. Expect more mergers and acquisitions amongst the active managers. That is not to say that specialist asset managers, with proven ability to generate alpha, cannot maintain a position.

Finally, I suggest you vote with your feet every now and then as nothing is more effective. Fund managers need to wake up. They simply cannot justify running with an unchanged fee structure when returns are a fraction of what they used to be and, in my experience, most investment managers only respect one thing.  

Management fees, in my opinion, should be set at a level where they cover the cost of running the fund management business, nothing more. As a result, they should be tiered to quickly reduce after a break-even point. Any excesses should be captured in a performance fee -  portfolio managers shouldn’t be allowed to get rich by charging as much as 2% (in the case of hedge funds) on large AUMs when the cost of running their businesses is substantially less expensive than this.

This article was first printed in the Financial Times on 07 November 2016
About the Author

Niels Clemen Jensen founded Absolute Return Partners in 2002 and is Chief Investment Officer. He has over 30 years of investment banking and investment management experience and is author of The Absolute Return Letter.