What is the cost of private markets as an asset class? And what is the role of performance fees? These pertinent questions were explored at portfolio institutional’s Private Markets Club Conference.
On the issue of cost, Jesal Mistry, head of DC investment at Legal & General, made some interesting observations. “The emphasis placed on cost is very high in DC. Probably higher than they should be.
“The dynamics in the industry have been focused on cost for some time,” he said. “Often to the extent that it comes away from the value and quality of a solution and comes down to a couple of basis points in fees.”
Therefore, Mistry added: “In my view, fees should be a second order point, it should be about how to get the best outcome for members, then how to do this at the best price.”
But when it comes to the issue of fees from an asset owner perspective, Rachel Farrell, director of public and private markets at Nest, raised an important point. “We believe that an allocation in private markets is not beneficial if the fees get too high.
“Cost is a significant drag on performance. And the performance fee can be a significant drag on returns,” she said.
Offering more insight to the point, Farrell added: “If you look at the type of returns you get from private markets, performance fees alone can be something like 2% to 4% a year.
“That gives you quite a big buffer if you are not paying performance fees. So cost is significant, it can eat your liquidity premium very quickly,” she said.
On this issue, Mistry countered: “Performance fees have their place, particularly in opening up various parts of the industry and could better align the interests of the saver with that of the manager.”
Mary Cahani, head of DC clients, UK institutional at Invesco, said that the Value for Money framework is important in offering clarity to the cost/fees debate.
“It is ultimately about what will give the members the better outcome,” she added.
“I worry when we get to a low fee that it gets to almost a tick-box exercise: the manager that can do it cheaper versus the manager who can do it better.”
Value for money
Addressing the issue, Mistry added: “I would say that the focus needs to be more on value for money.”
Although he expanded on this with an interesting point. “The Value for Money framework, which at the moment focuses on relative short-term performance, means we could see a shift away from the long term and long-term allocation to very short termism, which is a bit of a danger,” Mistry said.
Although Cahani agreed that performance fees should be revised. “The fees should only be when you are adding value.”
But she also noted that an excessive focus on fees can work against investors. “We should not hinder [pension] members access to good offerings just because there is a performance fee.
“If there is a fee barrier, is it enabling investors to access all [asset] managers? If you have that fee barrier it will hinder diversification,” Cahani said.
The argument should ultimately be about the return net of fees, she added. “If that net of fee is valuable, then it should be assessed on that basis.”
In reply, Farrell said: “Each asset owner needs to play to their strengths. And Nest looks for a very aligned relationship with its managers. So we negotiate pretty hard. On the other hand it is a large relationship that is cashflow positive for these managers.”
Philip Dawes, head of distribution at BNP Paribas Asset Management, said we have “been here before” with the focus on fees. “And look where that ended. In the context of DC, we are now stuck with 60/40 passive portfolios which are not really fit for purpose.”
He also noted that fees have played their part in where private markets are today. “Fees are one of the reasons private markets have not been adopted,” Dawes said.
Like others, the focus for him should be on value for money. “Illiquids will cost more money. But after fees do they add value? Yeah, it is worth paying for.”
Dawes added that performance fees are a cultural phenomenon that comes from across the Atlantic. “It is not necessarily shared by European asset managers,” he said.
“Asset managers should be willing to wait for performance fees in recognition of the fact that the portfolio is going to grow over time. So you are trading the up-front fee, or performance fees, for volume.”
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