After more than 20 years in the asset management business—most recently as CEO of AllianceBernstein—Peter Kraus realized he was in danger of being disrupted. The average active mutual fund manager was underperforming, net of fees. And the proliferation of passive products—low cost and simple—was affecting his business.
“The issue with disruption is, it’s affecting the other person,” Kraus says. “It’s never affecting you. Then, when you realize it is affecting you, that’s actually a very scary moment because you’re usually not at the beginning of the disruption. You’re usually pretty far down the line.”
After pouring over industry research, he came to the simple conclusion that what is wrong with the asset management business is the incentive structure. It is, he says, entirely out of whack.
“For years I managed managers who would come in my office and say, ‘Well, my capacity to manage my product is $10 billion,’” Kraus says. “They’d get the $10 billion, and they’d say, ‘You know, my capacity grew. It’s now $20 billion.’ I was arguing with them. They light their hair on fire. They run around my office. I’d say, ‘We agreed on 10. Why are you arguing it’s 20?’ Because, they can make more money. That’s what drives them. Ultimately, they want to make more money.”
Asset managers, like anyone else, are motivated by the compensation schemes they operate under. But the incentive structure in the asset management business, being paid a fee on assets, is not built to incentivize performance; it’s built to gather money.
“The only other way to make more money is if you pay them on performance, which we (as an industry) don’t do,” Kraus says.
So, in September, Kraus unveiled Aperture Investors, a new active asset management firm with a performance-linked fee model. Investors will pay an ETF-like fee based on the asset the firm is managing. Then, investors pay 30 percent on returns generated in excess of the fund’s benchmark, up to a cap.
“We know that nobody performs all the time,” he says. “But, the actual manager themselves will be more interested in controlling their capacity and actually performing if they’re paid on performance.”
So far, the firm has filed to launch an emerging markets debt fund and a global fixed income fund.
Kraus partnered with Assicurazioni Generali S.p.A., an Italian insurance company that also provides investment and wealth management services, which provided up to $4 billion in seed capital for managers’ use.
“That’s a huge benefit to a manager because when a manager is launching a new fund, generally they start with a small amount of money,” Kraus says. “They’re extended. They’re anxious about their expenses. They’re generally not paying themselves much. They’re focused on trying to raise assets.”
Aperture’s managers are, instead, focused on producing returns. To be sure, some would argue that performance-based fees incentivize too much risk-taking. “My reaction is, well, you have to understand the structure. If you understood the structure, the ecosystem in which the manager lives, you wouldn’t conclude that.”
Kraus believes financial advisors will naturally be cautious of his new model, but he believes it’s also an opportunity for them.
“Now, they can go to clients and say, ‘Look, I can now find a manager that’s incentivized consistently with you. And, you don’t pay anything other than an ETF-level fee if they don’t perform. That means your fees are lower. If they’re higher, you’re happy.’ If I was a financial advisor, I would bring that value proposition to my client and say, ‘I’m doing something for you.’”