Japan's Government Pension Investment Fund Dares Active Managers

(Bloomberg Gadfly) -- Active investment managers argue that increased market volatility provides an environment in which their stock-picking skills can shine. The world's largest pension fund wants them to put their money -- or rather their fees -- where their collective mouths are.

Japan's Government Pension Investment Fund, which has about 163 trillion yen ($1.5 trillion) of assets, is changing how it motivates its external active managers. Instead of paying them higher fees than their passive brethren as a matter of course, they will get equal compensation. Only if they outperform their benchmarks will the active managers see increased fees.

"Our external managers have tended to focus on getting more (assets) from GPIF and to avoid taking appropriate risks required to achieve their target alpha," GPIF said, according to the Financial Times.

Last year, GPIF had about 29 active fund managers in the fixed income space overseeing more than 14 trillion yen, and 27 in equities managing about 8 trillion yen, according to industry newsletter Asia Asset Management.  

The tendency of investment firms to morph into asset gatherers, where fee income is dictated by how much is managed rather than how good returns are, has been well-documented. It's a welcome development when one of the largest pools of assets in the world challenges that orthodoxy. And it's bang in line with where the world of fund management is and should be heading.

Fidelity International, which manages about 233 billion pounds ($330 billion), is introducing so-called fulcrum fees to active equity funds this month whereby it will levy more when the funds outperform their benchmark and less when returns are lagging.

Mercer, the consultancy firm owned by Marsh & McLennan, proposed earlier this month that active managers should compensate investors for any shortfall in performance compared with their benchmarks, as well as capturing any upside above a pre-agreed hurdle rate.

And a study published in August by Mark Chapman of Aquamarine Funds found a surprisingly large number of fund managers willing to accept management fees of zero, in return for taking a larger slice of any outperformance. The most typical structure was for the manager to take 25 percent of returns once the excess had beaten a 6 percent hurdle rate.

As Chapman notes, however, a manager willing to accept zero fees typically has "some other source of income, or is independently wealthy." The costs of starting up the business and the risk of underperforming in the first few years are a big deterrent, he says.  

So while zero fees are unlikely to catch on, the concept of active managers only getting paid when they outperform is clearly catching on.

Of course, no-one is forcing asset managers to accept the bargain offered by GPIF. They can stick with more pliant -- or gullible, depending on your take -- customers that don't demand outperformance in exchange for fees. But the direction of travel for the industry is clearly moving towards more risk-sharing by the active crowd.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Mark Gilbert is a Bloomberg Gadfly columnist covering asset management. He previously was a Bloomberg View columnist, and prior to that the London bureau chief for Bloomberg News. He is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”

To contact the author of this story: Mark Gilbert in London at magilbert@bloomberg.net.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net.

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