Should fiduciary management fees be linked to assets under management?

Why is this happening?

One key driver is the size of assets managed by fiduciary managers has fallen. A fall in asset values is not an isolated issue for fiduciary managers, it is widespread across the industry. However it has certainly hit fiduciary managers directly, In particular, those with a fee structure linked to the value of assets will have seen the £ amount of revenue across clients fall.

Inflation has also been on the rise. And fiduciary managers, like other business owners, face rising costs from salaries and utilities.

Furthermore, there has been an element of “scope creep”, meaning fiduciary managers are now providing more services than they would have around five years ago. This includes supporting trustees with embedding ESG into investments and enhancing overall performance reporting. It is assumed that a fiduciary manager’s service should be comprehensive and as a result the services are expected to be provided within the fiduciary management fee.

So, in summary, costs are up but revenue is down.

But surely this is a feature of asset management?

Investment markets are cyclical and for decades asset managers have had to cope with fees being sensitive to the whims of the market. One could argue fiduciary managers benefited in an environment of falling interest rates where the assets they managed grew and they got some reward for positive growth outside of their control.

However inflation is a real issue. It is rare to find a service provider who has not had to increase fees because of this. This is a tricky one though. You could argue if you started to dissect underlying asset movements, despite the fall in asset values, the contribution from increasing inflation to the asset value has been positive.

It is, however, fair to say that the services provided have increased. With new regulatory requirements around ESG investing and LDI oversight, fiduciary managers have to do more than they used to.

Also, fiduciary management is not asset management. It compromises advisory services plus asset management. And it is the advisory services component which one could argue should not be linked to the size of the assets. In fact, it is more typical for advisory fees to be fixed or be on a time and material basis.

With the variety of fiduciary management models in the market, the size of the fiduciary management fee only tells a fraction of the story. The total costs paid to a fiduciary manager vary as the asset mix changes and depending on the style of asset management offered. This is why it is important to understand the full costs of fiduciary management on a regular basis - not just at pitch stage.

How should fiduciary management fees be structured?

There are multiple structures which can be used when it comes to agreeing a fiduciary management fee. In my experience, the most common alternative is to have a fixed fee with an inflationary increase. This approach however can lead to an unduly high fee when inflation is high and assets are falling. A solution to this is to have a capped inflation increase.

The inclusion of a performance fee element is also a feature seen in some contracts. This is however extremely complex to negotiate to ensure it is fair for all concerned. Furthermore, the return required by the average pension scheme has fallen and assets held are simplifying. This leaves little room to justify any material performance fee element.

However, the most common fee structure still remains one linked to assets under management. And there are ways to make this work in a fairer way.

• One way is to have appropriate minimum fees in place. Whilst it might be nice for marketing reasons to say there is no minimum fee, the reality is there is a fixed cost to providing fiduciary management. Being upfront about this and how it is calculated could save a lot of pain in the long run.
• I would also suggest considering a maximum fee. This is not a common feature I come across in contracts. But, in my view, it is quite one-sided to only have a minimum fee. The cost of fiduciary management does not increase in proportion with asset size.

In combination, the use of minimum and maximum fees create a hybrid of the fixed and asset under management fee structures.

A tiered fee structure based on assets under management could also create a similar effect. Another option is a split fee structure with an asset management fee linked to the size of the assets and an advisory fee which is fixed.

Concluding thoughts

There is no perfect fiduciary management fee structure. There are always scenarios which mean the fee structure is no longer aligned to the spirit of negotiations. As long as this is understood and fees are kept under review, nasty surprises can be avoided.

It is important to understand total costs and services provided. When used well, investment consultant objectives and timely cost disclosures can be effective in assessing this.

I would also recommend applying greater scrutiny to exit costs and how the liquidity of assets impacts these. Fiduciary managers are required by law to disclose estimated exit costs at pitch stage. This is one area where the level of transparency remains poor. Mandates can change and it is not uncommon to see more illiquid assets introduced into the portfolio after the mandate begins. The consequence of not properly understanding this is coming to bear for some pension schemes looking to exit / switch providers.

Finally, be more methodological about reviewing fiduciary managers. One aspect of this is fees but performance has to come into the mix. This is critical for assessing value for money. Performance must be judged through multiple lenses and not just through the lens presented by the fiduciary manager.