‘You’ll never overpay for average performance’: $17 billion investor Westwood is trying a new fee structure as active funds try to win back capital

Westwood

Westwood Holdings Group, a $16.6 billion investment firm, is re-thinking fees as investors flee active products for cheaper passive funds.
This week, the firm launched a new fee model for its US large-cap strategy. Investors pay either no or a very small base fee, then only pay when the fund outperforms its benchmark.
Westwood follows a handful of other firms, including $500 billion AllianceBernstein and Aperture Investors, the start-up founded by AB’s former CEO, in linking fees to performance.

"Investors have lost confidence in active management," said Phil DeSantis, an executive at an active manager.

But DeSantis has a plan to build their confidence back up, and in the process, capture some of the money that’s been fleeing active management.

The head of product at $16.6 billion Westwood Holdings Group told Business Insider that his firm is attempting to innovate "in an industry that’s failed to innovate" by re-thinking traditional fee arrangements. The strategy should appeal to institutional and individual investors, who DeSantis said have been more concerned with fees in the last year than anytime in his 20-year career.

Investors have long been flocking to cheaper, better performing, and more tax-efficient exchange-traded funds. As they shun higher-revenue active products, asset managers are facing dismal growth projections, according to analysts at Morgan Stanley.

To counter that movement toward passive management, on Thursday, Westwood launched a new fee structure for US large-cap equities, part of what it branded WW IR Sensible Fees. The firm’s US large-cap equities fund for individual investors lost 6.3% in 2018, while its benchmark, the S&P 500, lost -4.4%, according to Morningstar.

Actively-managed US equities strategies charge an average of 0.73%, per Morningstar. Westwood’s two models for base fees, by contrast, start at either zero or an ETF-like fee, lower than other so-called "fulcrum fees," which also include variable fees based on performance. The firm only then charges when the strategy outperforms a benchmark, with the fee capped at 1.25%. The fee is linked to risk-adjusted outperformance, and the total fee can’t exceed 40% of the excess return.

Because only about a third of US institutional large-cap strategies outperformed net of fees in the decade ending December 31, according to data provider eVestment, DeSantis said investors are particularly keen to see payback for their active investments.

"It’s not just a different way to get paid; it solves a problem," said Harvey Steele, the firm’s head of intermediary distribution. "We essentially guarantee that you’ll never overpay for average performance."

He said Westwood is already in discussions with institutional investors, such as state pension plans, and brokerages that could offer the products. The Sensible Fees models will be offered first through separately managed accounts. The firm is also eyeing other asset classes, including liquid alternatives, for future Sensible Fees products.

Westwood isn’t the only investment manager re-thinking fees. In a white paper, the firm notes that former AllianceBernstein CEO Peter Kraus, among others, is working on a performance-based fee at his new venture, Aperture Investors. AB, a $550 billion manager, launched a set of fulcrum funds last year under the FlexFee Funds umbrella.

"We need to provide an inducement for clients to try active again," AB CEO Seth Bernstein said at Monday’s Bank of America Merrill Lynch Future of Financials conference. "They want to see better alignment of interests with the manager and end results."

Other managers eyeing the strategy have told Business Insider they’re waiting to see if sufficient money goes to AB’s fulcrum funds before building out their own strategies. So far, those six funds have raised $342 million, per Morningstar, with the smallest picking up just over $1 million.

"This would be really painful for large fund houses – they’d be loathe to do it," Westwood’s DeSantis said, citing the high costs of starting such a product, among other issues. "They’d have to cannibalize their own business."

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