It hasn’t been an easy decade for mutual fund managers.
The pressures come from all sides. Banks are laying off advisors—who have traditionally held the keys to a fund’s distribution. Clients are scrutinizing product fees, comparing lower-cost ETFs to mutual funds. And a year doesn’t go by without another SPIVA Scorecard showing how active managers have underperformed the benchmarks.
Lower-cost investing is a secular trend, fund managers concede. Algorithms, they say, don’t collect salaries. Mutual funds—which still hold 91.7% of the Canadian investment fund industry, compared to 8.3% for ETFs, according to Strategic Insight—are ripe for disruption. The rapid growth of passive and factor ETFs are pressuring mutual fund providers to take a harder look at fees, returns and headcounts—not to mention bonuses.
Large investment firms are already downsizing their active divisions as they invest in factor, or smart beta, ETFs. Earlier this year, for instance, Bloomberg reported that New York-based BlackRock planned to lay off more than 30 people from its active equity management group, including five portfolio managers. In Canada, BMO, the second-largest ETF provider by AUM, reduced its active management division by some senior people this year.
“The banks control the markets. Their platform is enormous,” says one Canadian asset manager, speaking anonymously. “There’s been fee compression from a number of places. The whole ETF experience is getting people to think, ‘Less for managers.’”
While portfolio managers have long received large bonuses based on returns, assets growth, star power and other metrics, compensation is under pressure.
Equity portfolio managers, on average, earned total compensation of $629,037 in 2014, according to CFA Societies Canada’s national survey. Pushed up by large bonuses at the top end, the average aggregate compensation had risen substantially from the 2011 survey data, when it was reported at $396,700. But overall, fund managers say, the tendency now is downward.
Mutual funds have had their stars; they grow assets and returns while earning a pretty penny. The names of active managers used to frequent advertising spreads and billboards—and some still do. Fidelity’s well-advertised portfolio manager Will Danoff—recently described on billboards as “The $108 Billion Man Who Has Beaten the Market”—is estimated to earn compensation in the millions, rivalling CEO pay.
But Danoff is more anomaly than norm, asset managers say. People like CI Harbour’s Gerry Coleman, Mackenzie Investments’ Ian Ainsworth or Sprott Inc.’s Eric Sprott represent bygone glory days, and so do their seven-figure-plus compensation plans.
One of several fund managers who spoke to AER, and asked to remain anonymous, says a senior manager of an average-sized fund could earn a salary of $200,000 to $400,000 before the ETF boom. At the high end, the bonus would amount to about three times their salary, with publicly traded companies offering some of the largest bonuses.
“It was hard not to get a 50% bonus,” the fund manager recalls. “I think across the board, it’s compensated a whole lot less than it was maybe 10 years ago.”
For PM bonuses, mutual fund performance is typically measured against a basket of peer funds. When the portfolio manager’s funds are well distributed within the investment advisor community, and report good returns, the bonuses are impressive. But if a fund’s distribution is lagging and returns are lower, how can it offer a generous bonus?
Fund managers say group rewards have become more common for portfolio management teams, offering more balanced bonus structures. Large financial institutions and asset management firms, meanwhile, are trying to avoid key-person risk—situations where they have to pay enormous sums to retain stars.
“A large number of active managers haven’t performed all that well,” says Kurt MacAlpine, head of global distribution at New York-based ETF provider WisdomTree who, before joining WisdomTree, led the North American asset management practice at McKinsey & Company. He says underperformance and “the commoditization of strategies” give rise to pricing pressures.
“When you have prolonged periods of underperformance—in addition to having redemptions, which obviously lowers your asset base and your ability to get paid—you also have to be more flexible with your pricing strategy,” he says.
Most advanced economies are grappling with these new competitive pressures. A recent study by the U.K.’s Financial Conduct Authority estimates that a £20,000 investment, put into an average active equity fund for the past 20 years, would have yielded returns nearly £14,000 lower than the fund’s respective passive ETF. A central reason? Fees.
Closet indexing—where an active manager follows an index to achieve similar returns—is no longer viable in an industry where cheap, passive ETFs can do the same thing for much less, say asset managers. Similarly, actively managed, large-cap core strategies, also easily replicated by low-cost, factor ETFs, are dropping off.
“It’s very difficult,” says a strategist with a leading ETF provider who formerly worked in wealth management. “Even if you’re one who’s truly doing well, if you have a year or two that’s bad, they’re going to lump you in with all the other people who’ve been doing closet indexing, or posing, for so many years. You have to overcome that now.”
BMO Global Asset Management downsized some PMs and managers from its buy-side equity team earlier this year. (The staff changes were first reported by Reuters and confirmed independently by AER.) As part of the reorganization, Lesley Marks, head of the bank’s Canadian fundamental equities team, moved over to BMO Private Banking as chief investment strategist, and some PMs left.
“We did make some strategic shifts, from fundamentally managed active towards quantitative active,” says Kevin Gopaul, head of ETFs and Canadian chief investment officer for BMO Global Asset Management. “I think some of the resources, the mandates, have evolved in that direction. It’s what the market is dictating to us.”
Canadian fund flows and assets
|Net flows, C$ millions|
|Product type||2012||2013||2014||2015||2016||YTD 2017*|
|Redemptions, C$ millions|
|Assets, C$ millions|
Data provided by Strategic Insight
*As of June 2017
Active management is changing rather than going the way of the compact disc. BMO’s asset managers are using more quantitative tools and analysis to help define stock-picking attributes, evaluate returns and measure stock momentum, and price movements, says Gopaul.
“The quantitative process adds more efficiency. They have the analysis, the portfolio construction, the overall portfolio risk, all done in one process,” Gopaul says. “Active management is changing, and people should embrace the change.”
Asset management firms will increasingly use quantitative tools, Gopaul predicts, given the lower costs of ETFs and the demands of the marketplace to be nimble. He adds that a growing number of active managers use ETFs.
“Now, there are more tools that are low-cost that one can use to deliver excess returns,” the BMO executive says. “It’s creating innovation and survival among active managers.”
Harry Marmer, executive vice-president of Hillsdale Investment Management in Toronto—who this year gave a presentation to CFA Society members entitled, “The Premature Death of Alpha”—welcomes the attention to performance.
“If you are a mediocre manager, this is another spotlight. Just like the IIROC rules—which expect more fee disclosure—this is another spotlight on ‘What are you doing for me as a client?’” says Marmer. “If the client wins, and bad money managers disappear, that’s a good thing.”
Mutual fund success based on AUM growth is perverse, Marmer suggests. AUM growth doesn’t necessarily reflect future performance, and loading up on assets can defeat the manager’s strategy. When a portfolio strategy exceeds its capacity, selling or buying a position can lower or inflate the asset price, increasing costs. The strategy breaks down, fund strategists say, leading managers to pad the portfolio with less confident names.
While passive and smart beta ETFs are popular now due to good marketing (“Who wants to buy dumb beta?” Marmer asks) smart beta, like active managers today, will someday face harsher scrutiny, he predicts. Single-factor ETFs lack the flexibility and resiliency of active managers over time, he says, and shrewd investors will hunt for compelling active strategies with performance-based fees.
Equity PM compensation
*Large bonuses at the top-end of PM compensation pushed up the average. CFA Society’s overall survey showed the highest-earning CFAs in 2014 had total compensation ranging from $290,000 to more than $10 million.
Source: CFA Societies Canada national surveys, 2015 and 2012 (using survey data from 2014 and 2011).
For active managers, there’s value in fewer names and high-conviction strategies. Active managers’ top, overweight positions tend to outperform; that was the thinking behind the Global X Guru Index ETF (NYSE Arca: GURU), which invests in hedge funds’ top picks. Active management teams can’t beat the benchmark with hundreds of stocks because they don’t have the time and resources to research so many companies. If you ask a team of five or six people to know everything about 150 corporations, don’t count on them to beat the S&P 500.
Gopaul says active management remains vital to BMO’s ecosystem. He agrees with the value in high conviction, seeing a future in active managers who use an investment thesis to pick a concentrated number of companies. “Give me your best 15 companies, for example,” he says. “We’re seeing that kind of dichotomy happen in the marketplace.”
For advisors, there are already ways to see how the best performing active management teams are being singled out—in the form of actively managed ETFs, for instance.
Raj Lala, chief executive of Evolve Funds Group, an ETF firm in Toronto, says ETF providers are searching out the best active managers to package into an exchange-traded vehicle. His firm is launching a suite of four actively managed ETFs, whose subadvisors include Nuveen Asset Management, Foyston, Gordon & Payne and Credit Suisse.
Lala cites preferred shares, high yield bonds, emerging markets and small-to-midcap as strategies where good active managers can outperform. Says Lala: “I think there’s a lot of global managers, with fantastic track records, who are interested in being a subadvisor to the Canadian marketplace.”
by Simon Doyle, an Ottawa-based financial writer.