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A performance fee flop in the US

The Rec List - Citywire USA editor, Alex Steger, clicks links so you don’t have to!

A performance fee flop in the US

NEW YORK - Cast your mind back to 2018, when non-transparent ETFs were just a slightly unwanted item in the regulator’s inbox. Back then active management had a different saviour. It wasn’t the vehicle that needed changing, the argument went, but the fee structure. (It’s rarely the strategy).

The idea that the fee structure was the problem was a theory pushed hard by Peter Kraus, both towards the end of his tenure as CEO of AllianceBernstein (AB) and then as founder of his new venture, Aperture Investors. At both firms Kraus oversaw the launch of flexible or fulcrum fee funds, whereby portfolio managers charge a low(ish) base fee, which then can go up or down, to a cap, depending on how much they out-perform or under-perform their benchmarks.

Krauss gave interviews, here, and here, expounding on the view that asset management’s focus on asset gathering rather than performance was the problem and that this fee structure could help alter how the industry was incentivized. 

The concept wasn’t new but the buzz, and number of launches that followed, were.

And then...

You may not have heard much about the funds since. That is, until last week, when two firms – AB and Alger – called time on some of their fulcrum fee offerings after about three years.

AB has filed to liquidate the AB FlexFee International Strategic Core portfolio, the AB FlexFee Emerging Markets Growth portfolio, and the AB FlexFee International Bond portfolio.

The funds are small. They have $7.5m, $7.3m, and $30.1m in assets under management, respectively, which probably explains the decision.

It is only fair to point out that some AB FlexFee funds are not being scrapped, such as the $373.5m AB FlexFee Large Cap Growth fund, the $161m AB FlexFee US Thematic fund, both of which have gathered assets. Ironically, this was the very focus Kraus wanted AB to shift away from.

Meanwhile Alger is to end the fulcrum fee structure on the $24.5m Alger 25 fund, and the $15m Alger 35 fund. Again, the size of the funds tells the story. The Alger 35 fund will move to have a fixed fee, while the Alger 25 fund is switching to become… a non-transparent ETF, and so must abandon its variable fee structure as it seeks, once again, to be at the forefront of active management’s next revolution.

Let’s hope this one lasts a bit longer.

Patience?

The irony here is that the Alger 25 fund is actually a pretty good active fund. It’s different to an index (the 25 in the name refers to the number of holdings in the portfolio) and it’s ahead of its benchmark and peer group since inception in December 2017.

While fees and vehicles pose problems for active managers, perhaps patience is the industry’s biggest issue.

Department of Labour ditches ESG

It was the most contentious political decision of the last few weeks.

It was the culmination of months of campaigning. It whipped the press into a frenzy, and divided families (maybe).

But by early November it was all settled. The will of the people had been heard… and the Department of Labor published its final rule on selecting ESG funds in 401(k) plans.

And while in large parts, the rule, which we have previous covered here and here, remained much as it had been proposed, there was one noticeable change: the letters ESG were nowhere to be seen.

OK, that’s not strictly true. The acronym appears in the final document, but only in the preamble and footnotes, and has been removed from the rule itself, which instead of saying fiduciaries should not select funds based on ESG factors, now says they should not select funds based on ‘non-pecuniary’ factors.

Which means?

Say what you want about the DOL’s rule – and 8,737 people have – but on this point, the agency is at least consistent. One of its gripes about ESG was that the term was ‘often unclear and contradictory’ and so it would have been hard to restrict considering ESG factors if no one can agree what they are.

Critics have argued that the final rule is not really any different to the initial proposal, and – of course – there are also those that argue that ESG factors do have a material effect on a fund’s risk and returns, making the whole rule both redundant and maddening.

But those looking for the rule to be overturned or tweaked might find most fertile grounds for hope in the change of power in the White House. According to a recent article by my colleague Jake Martin, Joe Biden’s frontrunners to replace Eugene Scalia as Secretary of Labor include Julie Su, Secretary of the California Labor and Workforce Development Agency, while ‘other names, including Senator Bernie Sanders and DNC Chairman and former Obama Labor Secretary Tom Perez, have also entered the conversation.’

Some kind of fiduciary rule is set to be back on the table, and there’s every chance the ESG rule has as short a shelf life as it did a consultation period.

Further reading:

 

Quick clicks

That’s it for this week. As ever, please send any links, thoughts, feedback, and general miscellany to me at asteger@citywireusa.com.

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