Monday, March 26, 2018

Japan's GPIF Puts Squeeze on Fees?

Attracta Mooney of the Financial Times reports, World’s biggest pension scheme overhauls fee structure:
Japan’s Government Pension Investment Fund has accused active asset managers of being too focused on gathering new assets rather than generating returns for clients, as the world’s largest retirement pot gears up to overhaul how it pays investment houses.

Under plans due to come into place in April, the $1.4tn pension fund will pay its active asset managers a fee that is based on the excess returns — or alpha — they generate. “Without excess returns, their fee must be equal to that of passive managers with the same amount of asset size,” GPIF said. The new regime will apply to new and existing managers.

The move by the pension fund comes at a time of growing questions over the value stockpickers add. Active fund managers have repeatedly been accused of charging high fees for disappointing performance in recent years.

GPIF said its current fee structure, where investment houses were paid higher flat fees, did “not motivate asset managers to achieve alignment of interest between GPIF and external asset managers”.

The fund added: “Our external asset managers have tended to focus on getting more [assets] from GPIF and to avoid taking appropriate risks required to achieve their target alpha.

“By introducing the new fee structure, we would like to build a win-win relationship between GPIF and external asset managers.”

Active fund managers are under intense pressure to change fee structures that many clients believe are unfair.

Mercer, the influential adviser to pension funds, recently proposed that asset managers should pay investors to run their portfolios and provide performance guarantees instead of earning fees regardless of the returns delivered to their clients.

Some active fund managers, including Fidelity International and Allianz Global Investors, have put forward new structures that would include lower flat fees, with the addition of a performance fee.

“[This move by GPIF is] the latest and most publicised example of how the old heads-I-win, tails-you-lose fee structure is withering on the vine,” said Amin Rajan, chief executive of Create Research, an asset management consultancy.

But he warned that many asset managers would be unhappy with the move, because a shift away from fees related solely to assets under management “can introduce extreme volatility into fund managers’ revenue stream”.

Active asset managers that run money for GPIF include Amundi, Schroders, Invesco, Eastspring, Nomura, Fidelity International, JPMorgan Asset Management and UBS.

According to GPIF’s own data, its actively managed Japanese bonds and equities holdings, as well as its foreign equities funds, generated negative alpha — the returns above benchmark — over 10 years.

Andrew McNally, chief executive of Equitile, an asset manager that charges a fee related to returns, said the fund industry is being forced to reconsider how it charges investors.

“It seems unrealistic for the financial outcome for the fund management industry to be unrelated to the financial outcome for investors, especially pension funds as large as GPIF,” he added. “We think this [move by GPIF] is the start of a long trend which will see fees for active managers increasingly dependent on performance.”

About 20 per cent of its GPIF’s assets were actively managed at the end of financial year 2016, the latest year data are available for.
So, Japan's pension whale is putting the squeeze on fees, at least to what pertains to traditional stock and bond funds which aren't delivering the required excess returns.

Is this the right approach? In a world increasingly dominated by low-cost exchange-traded funds (ETFs), you have to wonder why everyone in the world isn't doing the same thing, namely, putting the squeeze on fees on traditional stock and bond funds.

In Canada, the large public pensions don't need to put the squeeze on fees on traditional stock and bond funds because they do their own indexing and enhanced indexing based on factor investing internally, foregoing fees. They still invest in large active managers but the bulk of the traditional public equities and fixed income are done internally.

Why is GPIF putting the squeeze on traditional active managers? In short, because active managers are taking a beating in Europe and are still lagging their passive rivals in the US.

Still, active managers tend to flourish in tough markets which is the main reason I expect a lot of these active managers on GPIF's roster will accept the terms of the deal. As I stated on Friday in my comment on phishing for inflation phools, I expect much tougher markets over the next year or two, so I don't believe good active managers will oppose GPIF's terms.

In other non-traditional alternative investments, GPIF will continue paying big fees to gain access to top funds. In February, it awarded the global infrastructure investment mandate to UK-headquartered private equity firm Pantheon, a top fund-of-funds manager.

In real estate, the size of Japan’s largest institutions means that even a tiny allocation to real estate could make significant waves. For example, GPIF has a target allocation of five percent to alternatives, including real estate. If, within this allocation, the overseas real estate portion was 0.5 percent, this would equate to more than US$7 billion of new investment.

Unlike large Canadian pensions, GPIF relies exclusively or almost exclusively on external managers so it's critically important to track and mitigate fees across traditional and alternive investments. This isn't an easy job when you're a $1.4 trillion fund that needs excess returns.

This is something Hiromichi Mizuno, GPIF's CIO, knows all to well.

Below, a panel discussion at the Milken Institute featuring Hiromichi Mizuno, Chris Ailman, Jagdeep Singh Bachleer, and Carrie Thome. You can also watch Mr. Mizumo discussing ESG investing here.

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