FSI – active managers need to find their voice

15 December, 2014

David Murray is probably not top of the Christmas card list for active managers this year.

After all, they just got a chunk of the blame for the FSI’s conclusion that the Australian super system is not realizing the full benefits of scale: “costly asset management and active investment strategies” is the no.2 supply side issue cited.

According to the FSI, average total fees to members should have declined by 60bps since 2004, but have declined by only 20bps. Of the 40bps of increased costs offsetting scale benefits, 15bps relates to investment expenses. So it’s a big target for the FSI.

There’s a theme that much spend on investments is a waste of members’ money. The FSI argues that lower fees and costs means higher net returns and retirement incomes; ie that reducing investment costs has no downside. The only qualification offered by the FSI is in respect of infrastructure and other unlisted investments, which it says (somewhat grudgingly) may diversify risk and offer higher after-fee returns.

This implicitly says that active management of major public asset classes such as equities and fixed income either produces no net benefit, or imposes net costs on members.

This issue has been glossed over in the discussion of the FSI final report, but is one of its more controversial super-related conclusions:

• The great majority of super funds and their chief investment officers believe in active management, so the FSI effectively criticizes this aspect of their operating model.
• It’s (obviously) damaging to the business model of active managers.

The anti-active management view is a minority view, but one that is getting increasing traction, with the support of a range of interested parties:

• Passive managers question the value of active management; it’s their business model to do so.
• A few funds have gone down this road already – QSuper being a good example – restructuring portfolios to reflect active management of private market assets, but passive management of public market assets (perhaps with more diverse approaches to passive than just traditional cap-weighted benchmarks).
• External parties (such as the Grattan Institute) have arrived at policy positions critical of the use of active asset management by super funds.

This debate is not just an Australian phenomenon; it’s also a live issue in the UK, which we discussed here.

It would be fair to say that active managers – fund CIOs and active managers alike – have been largely blind-sided by the critical review from the FSI and the emergence of hostile external parties in influencing its conclusions. The active management community is used to competing with the arguments of passive managers of course, but has never seriously considered the possibility that it could be made largely redundant.

That degree of comfort should no longer be taken for granted in an environment where pressure is being exerted on fund trustees to cut default fees. Consider how an example default fee of 90 bps to a $50,000 member is comprised:

• ~15 bps represents administration costs
• ~10 bps represents trustee operating costs
• ~65 bps represents investment costs

It’s pretty obvious that the only way to make material inroads into the 90 bps default fee is to cut investment costs. Superstream will hopefully deliver operating efficiencies in administration, but even a one-third improvement would deliver only 5bps. And trustee operating costs are more likely to go up than down as competition for members increases.

So there’s a big target painted on active managers, both internal and external. If they don’t want to get shot, they need to find their voice and make the case for active management in a more effective and sustained manner than at present. We need to move from what is usually a technical, inwardly focused discussion, to an understandable and member-focused discussion of the benefits to them, and indeed the wider Australian economy.

To do this, funds need to be clear about what benefits they believe are being delivered by their active management program. Active investment managers need to be equally clear about how they add value to their investors.

Both need to communicate this loudly and repeatedly. Few do so particularly effectively at present (Roger Montgomery comes to mind in terms of exemplary communication of the benefits of active management to investors), and a vacuum has been allowed to form. Whenever you allow a vacuum to form, someone else will fill it.

The critics will maintain their anti-active campaign, and it’s largely one-way traffic at the moment. If they believe in what they are doing, active managers (funds and external managers alike) need to engage and regain the initiative in the debate.