Regulatory scrutiny, such as Mifid II, product governance and suitability, has brought increased pricing discipline and much needed transparency on discretionary fund management (DFM) fees.
This enables advisers and their clients to see how the fees they are paying compare to others in the market.
The general trend is that costs are now falling, albeit only gradually. But is a gradual reduction good enough for advisers and clients in the current climate?
Low growth is expected to lie ahead as a result of the Covid-19 crisis, with its impact likely to last for months or years to come.
As such, DFM costs remain under the spotlight and notably higher charges are not so easy to justify when returns are low. With this set to continue, how will fees be impacted in the future?
When to use active and passive strategies
A central element of DFM portfolio cost is in its design. Portfolios can be set up to achieve good value for money without sacrificing investment principles and overall objectives.
To achieve good diversification and access to the asset classes needed to achieve a client's objectives, sometimes it is the case that funds with higher fees are what's required to generate the required return.
This should be balanced, wherever possible, with low-cost, efficient index-tracking funds in other asset classes.
As we know, the cost of active funds can be significantly higher than that of passive funds.
In some cases, this can be shown to add value and represent an important portfolio ingredient.
But historic evidence shows that in many areas active managers tend to perform no better than the benchmark index before fees.
Of course, there are some managers who do perform better, but identifying which managers will outperform in the future, given uncertain market conditions and events is tricky.
Even managers who have long successful track records may underperform in different market conditions in the future.
For that reason, we believe the focus should on using passive management where there isn't strong evidence that active management can consistently and predictably outperform the passive benchmark.
That said, there are some areas where we believe active management can add value.
For example, we consider asset classes such as multi-asset credit and some property mandates to be better managed actively.
By using a small number of actively managed funds, where they can be expected to add value, but with cost-effective passive funds used elsewhere, this helps to get the best value for money.
It also avoids unnecessary fees where they aren’t expected to help performance.
Even relatively small fee savings (for example, by replacing some expensive actively managed funds with lower cost funds) can have significant effects over time.
At Hymans Robertson we have developed a tool called Track and Go which illustrates how much clients plan to withdraw from an investment in each year.
This shows the impact of higher and lower fees on the expected annual amount that can be withdrawn.
For example, if it’s possible to save 0.2 per cent a year on fees for someone withdrawing from a pot of £500,000 over 30 years, their annual income could be £800 a year higher.
Their pot at the end of a 30-year period could be £50,000 higher, allowing for the effects of compound interest.
Buying power and operational costs
Institutional buying power may mean that costs can be brought down further.
This can encourage more competitive pricing from asset managers, while smaller scale DFMs tend to be more limited in their buying power.
For DFMs there are other cost considerations too.
Well-run DFMs need to ensure robust governance in their stewardship of portfolios.
While firms may have efficient and experienced management frameworks to make sure this is the case, they still need to do so cost-effectively.
Others may be burdened by the costs of meeting their full obligations.
Similarly, a DFM should have a strong and efficient operations function. Expertise and sophistication of operational processes can vary between DFMs – efficiencies here can also impact the overall fees passed onto the client.
These functions will come under increasing scrutiny.
Advisers are dealing with a high number of retiring clients who are sensitive to late accumulation growth.
At the same time, advisers are shaping the propositions they want to deliver more clearly, particularly with the focus on product governance rules (PROD) and investment suitability for particular client types.
Early next year will see the FCA communicate greater expectations in this area too.
Well-judged sustainable withdrawal rates and centralised retirement propositions will all stand up better with lower fee burdens.
The future of fees
While uncertain times can make predictions difficult, there is a growing case for more disruptive pricing in the DFM marketplace.
Good client outcomes will depend on the quality of the investment proposition and minimised fees to flourish in a low growth environment.
At best, this is a significant short-term problem. Yet adviser expectations are rising here too, and the regulator is following close behind. Further pressure on fees seems inevitable.
It may prove to be the case that only some DFMs will have the capabilities and efficiency to respond and move the market forward on price.