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Mar 07, 2018

Mercer presents new asset management model

Guaranteed active management would see asset managers pay investors a fixed annual fee

Consulting firm Mercer has unveiled the concept of a radical new approach to asset management that would change the payment of fees and transform active management.

In a new review of market and active management practices, Mercer offers a model called ‘guaranteed active management’ in which an asset manager pays an investor a fixed annual fee and keeps all of the return over an agreed benchmark.

Divyesh Hindocha, a partner at Mercer and author of the report, tells IR Magazine: ‘A lot of discussion around active management has tended to focus on fees and some of the solutions discussed have focused on a better alignment of fees. What I am saying is that this merits a debate but, actually, it is more fundamental than that: it is much deeper than fees.

‘It is about how we can resurrect the idea of active management – because there is benefit in active management from a societal perspective. We should think about the model of active management and construct another model altogether.’

On how guaranteed active management would work, Hindocha says: ‘The idea is that the payment should be small in terms of basis points, but even at 50 basis points the additional return over 20 or 30 years increases the [investment] pot by 15 percent to 20 percent. So that small addition from active management means the pot is somewhat higher [than passive investments].’

Within the report is a reference to the 2011 Kay review of UK equity markets and long-term decision-making, which warned of the problem of short-termism in the UK equity markets and poor engagement between investors and companies.

‘This is all part of the mix,’ comments Hindocha. ‘There are a number of charges [against] the active management industry, from overcharging to not fulfilling a central role of capital allocation – and when you do [that] you are not looking after it properly. What Kay mentioned, and others have done subsequently, is the weakness of agency-based capitalism.’

This is the idea, also in Hindocha’s firing line, that collectively the business models and incentives of all the participant agents do not promote long-term value creation in the businesses in which capital is invested. Expanding on this, he says: ‘Therefore, it is about persuading the asset manager to act much more like a principal, not an agent. Because if you start acting like a principal – if the asset manager has skin in the game – it is not just taking the fees but, [rather], taking only success from the investment. And it will then start acting like a principal. That ought to result in better capital allocation and a stronger measure of capital.’ 

In turn, this opens up the environment for asset managers, Hindocha says. ‘If we freed up the asset management community to carry out its central function, it could benefit from a job well done and those [not doing a good job] would pay the cost. On the current model, on the whole, asset managers do well irrespective of how the [investment] strategy has performed.’

This means resetting a great deal of the work asset managers do. Asked whether they are capable of doing this, Hindocha responds: ‘The question is whether they are willing to open up this Pandora’s box and move to a different way of doing things. It is the willingness, not necessarily the ability. We will find out. But I think a small number of innovators will make the change. We have spoken to a number who have shown interest, and will continue to have such conversations.’