The rush for Saudi Arabia’s first international bonds issuance comes at a time when we are seeing increasing risk being taken by investors. They may not exactly be going for broke (yet), but the willingness to take more risk is clearly on the rise. No shock there. However, aside from altering asset allocation there are some things to consider to maximise returns.
Life cycle dynamics
Life cycle dynamics apply everywhere, whether you invest directly or through other investment managers. Back in the 1980s, when I joined the industry, IBM was the best thing since sliced bread, but it no longer is. Today, most investors think Apple is, but the day will arrive when it is also pushed aside.
In the fund management industry, life cycle dynamics also apply. Many larger fund managers have delivered very disappointing results in recent years. The near zero risk-free rate of return is undoubtedly part of the reason behind the relatively poor performance, but another reason, I believe, is size (assets under management).
Post 2008, many investors consolidated their investments. In principle, that was not a bad decision, but in practise it was, as deteriorating liquidity made, and continues to make, life difficult for many large investment firms.
On top of that, if you earn 2% in management fees on $10 billion of AuM (as some of the larger hedge funds do), your annual fee income before having delivered any returns at all is $200 million, and that sort of money buys a pretty decent lifestyle. Most of these people will not admit it, but size creates complacency. Suddenly the yacht in the Mediterranean becomes a more important gadget than the mobile phone, and that is a slippery slope.
My advice is to always consider life cycle dynamics. Don’t use this argument as an excuse to seed new investment managers, but be prepared to jump on the bandwagon relatively early, as younger, smaller, and nimbler investment managers often deliver superior returns.
Secondary opportunities
Talking about investing in funds, I have noticed that, in the post-2008 environment, investors don’t always ‘respect’ redemption terms, which has created a meaningful secondary market in funds with longer liquidity terms.
An investor may be exiting a fund prematurely for all kinds of reasons that have nothing whatsoever to do with performance, and that can be taken advantage of. Don’t let your investment decisions be driven by what’s on offer at the moment but check, once the decision to invest has been made, whether the fund in question can actually be acquired at a discount in the secondary market.
Voting with your feet
Finally, I suggest you vote with your feet every now and then. In a low return environment, fund managers are unlikely to perform sudden miracles and deliver outsized returns so, in that respect, you have to be realistic.
Fund managers, on the other hand, also 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. Vote with your feet, if you are not happy. Nothing else will have any effect whatsoever.
Whilst I entirely agree with the overriding philosophy that it is the net return after fees that really matters, in a low return environment, fees do make a big difference to the bottom line and fund managers should wake up to this At the very least, in my opinion, hurdle rates should be implemented before performance fees ‘kick in’ and performance fees should only crystalise annually – any more frequently and managers can be handsomely rewarded for strong monthly/quarterly returns even though annual returns are modest (and possibly negative).
Lastly 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 – PM’s shouldn’t be allowed to get rich by charging 2% on large AUMs when the cost of running their businesses are substantially less expensive than this.
Niels Jensen is founder and chief investment officer of Absolute Return Partners.
