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Overview of Investment Management Fees June 14, 2016 Why Do Plan Sponsors Pay Investment Management Fees? • All investment managers, whether active or passive, charge fees to their plan sponsor clients. Passive managers charge the lowest fees relative to all investment managers. • Fees for traditional active, public markets managers range widely depending upon the asset class and sub-asset class. • Fees for private markets managers tend to be in the 1.25% to 2% range and typically involve an additional incentive component which may be structured in varying ways – Percentage of performance earned above hurdle rate – Percentage of performance earned relative to a benchmark Alternative strategy fees: Traditional active fees: 7‐30 bps for core fixed income, 2% + 20% incentive above hurdle rate for hedge funds and private equities Passive fees: 35 to 100 bps for U.S. 0 to 20 bps and Developed Markets equities 1 Why Do Plan Sponsors Pay Investment Management Fees? • Fees charged by active investment managers are required for the following: – To cover compensation costs of all firm personnel which not only includes investment professionals but also investment support personnel (research, trading, legal, compliance, operations management, administrative support, etc.) and overhead (i.e., employee benefits, rent, insurance, utilities, etc.), – To cover costs of infrastructure and resources which support investment products (i.e., external research, risk analytics, trading and guideline implementation systems, marketing and distribution, etc.) – To meet profit margin targets. Profits are necessary to: fund future growth initiatives allow for expansion of staff and resources fund incentive compensation structures provide capital cushion to weather volatile environments or periods or poor performance provide capital to grant ownership to employees or to pay dividends to existing employee owners • Fees differ by investment products – Strategies that involve fundamental research require bigger staffs versus quantitative or modeldriven strategies. – Strategies may have higher implicit and explicit costs versus others (i.e., external research, larger broker/dealer spreads (e.g., EMD), high legal costs (e.g., high yield bonds), etc.) – May require specialized expertise in market segment or industry (biotech, information technology, etc.) etc. that is difficult to scale or expensive to maintain Types of Fee Structures • There are three types of investment management fee structures: – Asset-based fees Most commonly employed in traditional, public markets products Pro: when markets decline, manager will experience lower fees Con: generally increase over time as assets increase due to market movements – Incentive-based Most commonly employed in alternative investment products Pro: aligned with client as fees increase when manager skill produces positive results and decline when managers underperform performance hurdles or benchmarks Con: If not capped, can be outsized relative to benefit to clients from positive relative performance. Also, may not be fully transparent or easy to communicate. – Flat Annual dollar fee; rarely used by investment management firms. Generally employed by consultants and other non-investment management vendors 3 How are Fees Measured? • Fees are measured on both an absolute basis and peer relative basis • Absolute fee measurements involves measurement of fees in terms of impact on total fund returns – Large institutional investors pay absolute fees generally in the range of 30 bps to 70 bps • Peer relative fee measurement involves evaluation of fees versus peer strategies and peer funds of similar size. – Difficulties in peer fee comparisons due to: Differences in asset allocation Amount in active versus passive Internal versus external management – Other issues typically associated with peer measurements include survivorship bias 4 LACERS’ Fees Relative to Peers1 • LACERS costs for the 5-years ended 12/31/13 were modestly below peers, 50.9 bps versus 51.9 bps. • Lower costs were driven by implementation approach employed by LACERS: – Higher utilization of passive – Lower exposure to alternatives – Less utilization of fund of funds – No overlays 5 1 Source: Investment Cost Effectiveness Analysis (December 31, 2013) prepared for LACERS by CEM Benchmarking LACERS’ Fees Relative to Peers2 LACERS Public Markets Managers U.S. Equities Aronson, Johnson & Ortiz EAM PanAgora Asset Management Principal Global Inv Rhumbline Advisors ‐ S&P 500 Rhumbline Advisors 1000 Growth Rhumbline Russell 2000 Rhumbline Russell 2000 Growth Rhumbline Russell 2000 Value Non‐U.S. Equities Axiom International DFA Emerging Markets QMA AQR Capital Barrow Hanley Lazard Asset Management MFS Inst. Adv. Oberweis Asset Mgmt State Street Equity Core Bonds Baird Advisors LM Capital Group Loomis Sayles Neuberger Berman SSGA U.S. Agg Credit Opportunities Aegon USA Prudential Emerging Sankaty Sr Loan Fd L‐SL Public Real Assets DFA TIPS Core Commodities CenterSquare Universe Fee Median Universe Number of Managers in Universe LACERS Fee Universe Fee Ranking for LACERS Product Universe Fee Range 25 bps 83 bps 66 bps 40 bps 0.60 bps 0.50 bps 0.50 bps 0.50 bps 0.50 bps 1st Percentile 45th ‐ 50th Percentile 20th ‐ 25th Percentile 5th ‐ 10th Percentile 1st Percentile 1st Percentile 1st Percentile 1st Percentile 1st Percentile 25 bps to 85.2 bps 67 bps to 100 bps 42.8 bps to 98.7 bps 36.9 bps to 96.5 bps 0.6 bps to 23.2 bps 0.5 bps to 5.5 bps 0.5 bps to 63.3 bps 0.5 bps to 12 bps 0.5 bps to 11.8 bps 47.2 bps 83.2 bps 77.6 bps 63.1 bps 4.1 bps 4.8 bps 8.3 bps 9.5 bps 9.5 bps Separate Active Large Value Equity Separate Active Small Growth Equity Separate Active Small Value Equity Separate Active Mid Core Equity Separate Passive Large Cap Equity Separate Passive Large Growth Equity Separate Passive Small Cap Equity Separate Passive Small Growth Equity Separate Passive Small Value Equity 260 166 46 61 29 3 15 2 2 75 bps 52 bps 41 bps 78 bps 53 bps 57 bps 54 bps 95 bps 2 bps 25th ‐ 30th Percentile 5th ‐ 10th Percentile 5th ‐ 10th Percentile 35th ‐ 40th Percentile 35th ‐ 40th Percentile 50th ‐ 55th Percentile 40th ‐ 45th Percentile 70th ‐ 75th Percentile 10th ‐ 15th Percentile 27 bps to 161 bps 26.4 bps to 161 bps 26.3 bps to 161 bps 33.1 bps to 125 bps 32.2 bps to 98.2 bps 29.7 bps to 98.2 bps 20.8 bps to 98.2 bps 75 bps to 125 bps 0.2 bps to 30.1 bps 82.1 bps 81.7 bps 81.6 bps 81.8 bps 56.4 bps 55.8 bps 56.2 bps 91.5 bps 8.3 bps Separate Active Emerging Markets Separate Active Emerging Markets Separate Active Emerging Markets Separate Active EAFE Sm Cap Separate Active EAFE Separate Active EAFE Separate Active Global‐Ex US Separate Active EAFE Sm Cap Commingled Passive Int'l Equity 186 186 186 42 270 270 107 42 13 12.5 bps 13 bps 12 bps 15 bps 4 bps 5th ‐ 10th Percentile 1st Percentile 5th ‐ 10th Percentile 15th ‐ 20th Percentile 70th Percentile 11.3 bps to 38.7 bps 13 bps to 29.4 bps 8.9 bps to 29.3 bps 8.9 bps to 29.3 bps 2 bps to 5 bps 23.5 bps 22.3 bps 20.5 bps 20.5 bps 3.4 bps Separate Active Intermediate US Fixed Separate Active Core U.S. Fixed Separate Active Core U.S. Fixed Separate Active Core U.S. Fixed Commingled Passive Core U.S. 116 127 127 127 2 38 bps 47 bps 50 bps 5th ‐ 10th Percentile 30th ‐ 35th Percentile 50th ‐ 55th Percentile 33.3 bps to 75.8 bps 18.3 bps to 74.9 bps 46.9 bps to 69.4 bps 48.2 bps 51.5 bps 49.9 bps Separate Active U.S. HY Separate Active EMD Separate Active Bank Loans 163 42 60 6 bps 86 bps 48 bps 10th ‐ 15th Percentile 75th ‐ 80th Percentile 5th ‐ 10th Percentile 1.6 bps to 25.2 bps 29.7 bps to 150 bps 9.3 bps to 90.7 bps 11.3 bps 64 bps 63.2 bps Separate Active TIPS Separate Active Commodities Separate Active REITs 22 24 32 6 2 Sources: LACERS and Wilshire Associates Inc. LACERS’ Fiduciary Duty with Respect to Fees • Fiduciaries are subject to strict standards of conduct because they must act on behalf of the participants and beneficiaries of a retirement plan. One of the tenets of fiduciary responsibility is to pay only for “reasonable” plan expenses. • Reasonableness of fees is determined by comparing the fees of a strategy under consideration with fees for peer strategies. – Reasonableness can also be gauged by comparing strategy fees versus fees for passive alternative, if available. • Fees should be one of the components evaluated when selecting an investment manager. • After hire, fees should continue to be monitored to ensure they remain “reasonable” 7