ETF Surge Spurs Fee War Mobius Says Fund Managers Can’t Win
(Bloomberg) -- A decade ago, running an emerging-market fund meant traveling to faraway lands, taking big risks on high-yielding assets — and being rewarded with some of the highest fees in the industry.
These days the risks, and rewards, have shrunk. Competition is rising from passive funds able to generate similar returns at a fraction of the cost, and money managers are finding it increasingly difficult to justify charges 50% higher than those of their developed-world peers.
"When we started out, we were the only game in town — we could revel in being exclusive and have clients come to us and pay the fees we were asking for," Mark Mobius, executive chairman of Templeton Emerging Markets Group, said by phone from Dubai. "Now there are hundreds of funds in emerging markets, including ETFs. We have to either really perform better so we can justify the fees, or lower the fees."
Templeton has reduced charges on some products where performance has lagged, said Mobius, one of the earliest emerging-market investors. It's not alone: Pioneer Investment Management cut the fee on a new emerging-market fund it launched in June 2015, to one basis point below that of its older funds. And Jeff Levi, who consults money managers on strategy at Casey Quirk by Deloitte, says emerging-market hedge funds have increasingly been dropping fees.
This year has proved more than ever before that emerging-market money managers, often regarded as more resilient to the rise of passive funds because they operate in more opaque markets, need to follow their developed-world peers in adjusting to a changing environment. Asset managers including Janus Capital have countered outflows with mergers. Fees have fallen by about 11% in the past three years, according to data from the Investment Company Institute and Lipper.
Of the $47 billion that poured into emerging-market funds in the first 10 months of 2016 amid a global hunt for high-yielding assets, three-quarters was allocated to exchange-traded funds that passively track index benchmarks (ETFs). That was before Donald Trump's surprise victory in the U.S. presidential election last week, which sent money streaming out of emerging-market bond funds. The number of emerging-market ETFs has nearly quadrupled since 2010, to 224, and a BlackRock ETF has overtaken its active peers to become the biggest bond fund tracking that asset class.
"The fee is how far behind the starting line you have to start the race," said Eric Balchunas, an ETF analyst at Bloomberg Intelligence. "If you have all those evil nasty costs, it doesn't matter if you beat the benchmark any more, people aren't buying it."
U.S. mutual funds investing in emerging-market equities have an average expense ratio of 1.02% of total assets, according to the ICI data. That's 50% more than the 66 basis-point average charged by mutual funds investing mainly in developed-world stocks and seven times more than the 15 basis points charged by the Vanguard FTSE Emerging Markets ETF.
Money managers from companies including GAM U.K. and Invesco Asset Management are holding their ground, saying they offer added value because they can understand and react to constantly evolving risks in developing countries.
The real test will come now that the market has been hit with a shock selloff, according to Avi Hooper, a portfolio manager at Invesco. The $9 billion iShares JPMorgan USD Emerging Markets Bond ETF suffered its worst daily outflow on record on Thursday as prospects that Trump's policies will boost spending and quicken inflation sent debt markets into a tailspin.
The Julius Baer Multibond, a local-currency debt fund managed by GAM, has kept its expense ratio at 1.3% for institutional clients for 16 years, according to Ralph Gasser, a product specialist for the firm. He sees no reason to change now, either, after the fund outperformed its benchmark by 3.4% in the past year and attracted $1.2 billion in inflows.
"We offer superior value and that can be clearly demonstrated," Gasser said by phone from Geneva. "Why should you sell a Porsche for the price of a Lada?"
The problem is that most mutual funds, whether investing in emerging or developed markets, aren't Porsches. Study after study has shown that active managers consistently do less well than their benchmarks across asset classes, according to Stephen Tu, an ETF analyst at Moody's Investor Service. Over the past decade, more than 80% of U.S. active equity managers underperformed their benchmarks, S&P Global said last year.
Even when mutual funds do beat the benchmark, it's no guarantee of inflows. Pimco's $3.5 billion Emerging Markets Currency Fund has lost $400 million in assets this year despite returning 0.8% more than the benchmark.
This means that while a small minority of money managers with a proven track record may prove more resilient to a drop in fees, the middle group will have to fight their ground against a growing number of ETFs, all of which are already vying with each other to offer the lowest fee. New Labor Department regulations in the U.S. that encourage pension funds to opt for low-cost, transparent investment products will further boost the appeal of ETFs, according to Tu.
"We're in the midst of a price war where no market is safe," Tu said. "Everyone is trying to figure out how to gain new market share. It's only a matter of time before emerging-market funds start reducing fees as well."