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As institutions re-direct risk budgets toward esoteric strategies, traditional managers rethink product development initiatives and negotiation tactics
December 2019, BOSTON—U.S. institutional investors are consolidating their manager rosters in more commoditized, efficient markets strategies. As they reduce spending on this portion of their portfolio, they simultaneously increase spending on esoteric products that are more apt to attract excess returns. Cerulli's North American Institutional Markets 2019 report covers how this change in spending behavior is feeding into a broad re-allocation of risk budgets and subsequently affecting industry pricing dynamics. The report explores how managers can respond to this trend with thoughtful product development initiatives aimed to fulfill client objectives and simultaneously streamline pricing decisions.
After the 2008 recession, institutions achieved cost reductions by transitioning from actively managed strategies to passive. More recently, institutions have been achieving cost reductions by consolidating managers in the remaining active portion of portfolios. “Institutions have gained the upper hand in fee negotiation,” says James Tamposi, senior analyst at Cerulli Associates. “By re-directing their portfolios to fewer active managers and, hence, making larger allocations, institutions are securing better rack rates and leveraging bargaining power in the fee negotiations.” Beyond explicit cost savings, manager rationalization has enabled institutions to generate tracking error and simplify investment committee oversight responsibilities.
This power play does not affect all managers equally. The report finds that capacity-constrained strategies are relatively insulated from pricing pressure. Compared to other asset classes, for example, private investment strategies have seen the least amount of fee compression. Speaking to the disparity between public and private equity managers’ bargaining power, Tamposi suggests that private equity managers simply have more leverage: “Top-tier private equity managers are increasingly difficult to hire—a large dispersion of returns in the space has enabled top players to raise funds quickly while investors compete to secure allocations. These managers can command a higher fee and consume and increasingly large portion of institutions’ risk budgets.”
In the face of price competition and dwindling bargaining power, asset managers are evaluating their existing systems for fee negotiation. They need to consider a multitude of factors during the price negotiation process, including potential non-investment services required. Cerulli’s survey of corporate defined benefit plans found that on an asset-weighted basis, 42% of corporate defined benefit plans heavily emphasize risk analytics as an additional, non-investment service provided. “Managers need to incorporate these services into negotiation and pricing considerations, as they are often a significant strain on resources,” says Tamposi. Other factors considered by managers include the size of the mandate in question, the demand for the strategy, investment capacity in the strategy, and the existence of most-favored nation clauses (MFNs).
Managers should holistically evaluate their product lineups and consider the breadth of their vehicle offerings. While any institutional business should offer separate accounts, managers should be somewhat selective in their provision. Cerulli finds that more managers are aiming to incentivize clients into commingled funds, as managers can achieve better scale with these products. By having an exhaustive vehicle offering with fluid pricing, managers can address many of the pricing obstacles facing the industry today. Cerulli’s report explores the structuring and prioritization of product development and pricing initiatives that will position managers for sustainable success.
NOTES TO EDITORS:
These findings and more are from The Cerulli Report―North American Institutional Markets 2019: Institutional Product Development and Fee Negotiation.
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