Blog Surviving Management Fee Compression

Posted April 30, 2017 by Saadiah Freeman

Management fee compression is a big concern for most asset management firms – and with good reason. As we outlined in our recent white paper, Capitalizing on Disruption: Transforming Asset Managers for 2020, regulatory initiatives, the growth of passive products, and the increase of fee-based advisory business are all exerting downward pressure on mutual fund fees. In addition, broker-dealer consolidation and cuts to distributor product line-ups are creating increasing competition for shelf space. Indeed, amongst US equity mutual funds, only the lowest fee decile garnered positive net flows over the course of 2016, with all other deciles experiencing net outflows.

US Equity Mutual Funds: Net Flows ($B) by Management Fee Decile
(1 = lowest fee, 10 = highest fee)

Distribution Solutions Surviving Management Fee Compression illustration

Unsurprisingly, funds in the lowest fee decile are also, as a general rule, the largest funds. The average fund size for the lowest fee decile US equity mutual funds was $13.1 billion in 2016, more than twice the size of the average fund in the second lowest fee decile. With larger funds able to support lower fees more easily, this creates a virtuous circle for firms with big, low-cost funds, but it creates a challenging competitive environment for funds that don’t fall into this category.

US Equity Mutual Funds: Average Fund Size ($B) by Management Fee Decile

Distribution Solutions Surviving Management Fee Compression illustration

So, should firms abandon all hope for smaller, higher-cost strategies and focus their energies on their biggest and cheapest funds? Not necessarily. Strong opportunities still exist for differentiated active strategies with a proven track record of generating alpha, even though management fees for these types of funds are often higher than average. For example, an analysis of net flows into/out of small-cap US equity mutual funds paints a different picture. While net flows into the cheapest decile (1) still dominate, deciles 3,4 and even 7 also enjoyed positive net flows in 2016.

US Equity Small-Cap Mutual Funds: Net Flows ($B) by Management Fee Decile

Distribution Solutions Surviving Management Fee Compression illustration

Although the wider universe of small-cap companies can make it easier to develop specialized equity strategies, it’s possible for savvy firms to create – Fee Compression 3and promote – differentiated strategies within the large-cap space as well. While the big picture can look discouraging, success stories can still be found. For example, amongst large-cap US equity funds, nearly a quarter (24.4%) of funds in fee deciles 6-10 (that is, funds with above average management fees for their category) still achieved positive net flows during 2016.

In essence, despite downward pressure on fees overall, advisors and investors are still willing to pay for quality products. On the other hand, funds that don’t generate consistent alpha will be forced to compete on price. Given this, asset managers need to take a hard look at their product offerings, cutting fees on (or even eliminating) “me-too” funds and aggressively promoting actively managed strategies that outperform the market.

Saadiah Freeman
Engagement Manager
Research, Analytics, and Consulting

categories: fund distribution, etf/etfs, industry trends, wholesaler compensation

The views expressed in this publication are solely those of the author and do not necessarily reflect the position or policy of DST Systems, Inc. or its affiliates, subsidiaries, joint ventures, officers, directors, or management.

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