Stretched Thin, Firms Hack Away at Expenses
As Performance Plummets, Funds Look for Ways to Reduce Costs
April 6, 2009
As mutual fund assets continue to decline and investors migrate to low-cost products, fund companies are struggling to make management fees stretch even farther.
In addition to cutting staff, already lean firms will need to seriously consider automating or outsourcing various functions, merging smaller funds and eliminating some funds altogether.
"All fund groups have suffered substantial losses of assets under management, which has been reflected quickly in earnings," said Burt Greenwald, president of the Philadelphia-based consulting firm B.J. Greenwald & Associates. "Funds will obviously look at expenses as one area where they can exercise control. This is particularly true in publicly owned companies."
"Not so long ago, funds were launched with high initial fixed costs under the belief that market gains would continue to push forward," said Paul Ellenbogen, director of board consulting services at Morningstar Associates. "Those high, initial fixed costs have become a ball and chain, and expense caps have become a liability for advisors."
New funds put expense caps in place with the expectation that their fund will be small for a short period of time, after which the caps will go away, Ellenbogen said. Instead, those caps are staying put-even as assets flounder.
The problem is that firms can't raise fees to cover rising costs, and even though investors have become keener on low-cost funds, they aren't seeing the fees get any lower. "No one is really happy," Ellenbogen said.
The majority of fees are asset-based, said Keith Brown, president of the Boston-based Beacon Consulting Group. Fixed costs are steady even when assets are declining, meaning that funds' operating costs are trending upward, he said.
"As the market takes away assets, or as investors withdraw assets, funds are going back up that staircase, up to higher breakpoints," Ellenbogen said.
Performance fees can also have a bizarre effect in down markets, he said. When a fund outperforms its benchmark, its fees typically go up, but investors get irritated when their fund loses 35% and their fees go up anyway because their manager beat the S&P 500 by 200 basis points.
Assets under management are down 20% to 40%, he said. One-year returns are down 50%. Some $200 million funds are now worth $100 million.
"It's pretty bad when almost half of funds aren't at the critical point for profitability," which Ellenbogen says is $100 million. "This is a big problem for at least half of all mutual funds."
Many firms will need to merge smaller, underperforming funds and declare some obsolete, he said.
"A lot of companies feel they need to have every imaginable strategy, while only two or three of their funds hold the majority of assets," Brown said. "There are really significant, immediate savings in product rationalization."
"There have been an awful lot of layoffs. People are such a big cost," Ellenbogen said. Even the largest, most cost-effective funds are being forced to cut people, he said, noting that mutual fund titan American Funds recently announced it was cutting an additional 500 employees.
Greenwald said the industry's initial staffing cutbacks last fall were followed by two to three more waves, along with hiring freezes and salary freezes.
"We are seeing layoffs and staff cutbacks across the board, but that hasn't translated into savings to shareholders," Brown said. "There is not a direct correlation between headcount and lower fees."
"You won't hear firms saying, 'Now that we've laid off 25% of our staff, we're going to start lowering our advisory fees,'" Ellenbogen said. "Fund fees tend to be very sticky on the way down."
Until there is evidence of a real turnaround, there is very little companies can do to influence inflows or the appreciation of markets, Greenwald said.
"Asset values have declined, yet advisors' primary expenses-people and technology-remain largely fixed, likely cutting into their profit margins," said Edward O'Brien, senior vice president of institutional wealth services at Fidelity Investments. "As a result, enhancing profitability through greater efficiencies has become critical. In times like these, with margins under substantial pressure, advisors need all the time they can get to spend on profitably growing their practices."
Besides slashing staff members, firms can consider other cost-cutting alternatives, such as automating manual processes, putting more information on the Internet rather than through print-outs and mailings, and outsourcing work to low-cost, third-party administrators.
"In the current economic environment, mutual and collective fund companies face a greater need to reduce fund expenses while retaining customer business and satisfaction," said Pat Centanni, executive vice president and head of global product management at State Street Corp.
Funds can replace manual or partially automated processes and outsource paperwork-intensive, administration processes to provide broader functionality, scalability and accuracy, Centanni said.