Since 2014, the kickback fee, also known as distribution fee, has been abolished in the Netherlands. Prior to this, asset managers would continuously pay a fee to distributors whenever investments were made in the asset manager’s funds.
Naturally, the customer footed the bill in the form of a higher management fee, out of which the kickback fee was paid. Essentially, the distributor then earned twice: once from the fee the customer had to pay and once from the fee from the asset manager. The abolition of the kickback fee therefore leads to margin pressure, and the obvious solution is cost-cutting.
These cost savings have become particularly visible to the customer at the front end. Each advisor has to serve more clients and under the guise of digital transformation, the same client is now offered a standard solution. But savings were also made at the back end, where more and more tasks are accumulating.
The back end of such a distributor is called a back office. Good back-office staff are scarce and therefore not cheap. At the same time, regulators are imposing increasingly stringent requirements on the selection of investment funds. Where a new fund could be launched within a day in the past, the process now takes much more time. The rules are there mainly to ensure that every institution chooses the best possible investment solution for the customer. Now that the kickback fee has disappeared, there are no other incentives not to go for the best solution.
Economies of scale
In practice, such back-office functions are increasingly being outsourced. On the one hand, this is logical, as economies of scale play a significant role here. Particularly considering the required transparency in the ESG area, there are very few distributors who can do all this themselves. On the other hand, outsourcing means an extra link between the asset manager and the distributor. And that link also wants to make money. On the one hand, this can be achieved by charging the distributor a fee, but given the desired economies of scale, this link wants to attract as much invested capital as possible. This means that outsourcing must be more attractive to the distributor than doing it themselves. So, it’s not going to be a cash cow.
At the same time, this link also charges the asset managers a fee. They were surprised, as they were not used to contributing to what is effectively the back-office service of the distributor. The strange phenomenon now arises that a direct fee from the asset manager for the work on the back office can be seen as a kickback fee, somewhat comparable to soft-dollar contracts where asset managers, for example, pay for a Bloomberg subscription, but an indirect platform fee for outsourced back-office work can still be made.
In the end, the economy revolves around incentives, and here too the incentives are now shifting to the intermediary. This intermediary has little to do with the end customer, while the distributor is simply relieved that costs have been saved, thus optimizing profit margins. Not every asset manager, however, pays the same fee to the platform. There are asset managers who simply refuse to pay a fee, which effectively results in their funds no longer being purchasable by the distributor. Sometimes they are still on the platform, which mainly means that it can take much longer for the customer to purchase or sell them.
Substantial discount negotiated
Now, the larger asset managers will manage. They have likely negotiated a substantial discount and also ensured that all their passive products are available on such a platform. But asset managers who, under pressure from passive investing, have actually reduced their management fees, do not have much room left to pay this new fee. This means that relatively inexpensive funds on the platform can no longer be purchased and ultimately asset managers who pay the highest fees to the platform will therefore quickly receive premium treatment. This reduces the likelihood of the customer actually getting the best possible investment in their portfolio.
In principle, the profit margin of an asset manager lies in the management fee and this is often the part that funds are usually compared on. However, it is better to take all costs into account, also because part of the margin seems to be shifting to the other and therefore less visible costs. In this context, it might be wise to actually label kickback fees to intermediaries as such, even if only under the euphemistic heading ‘platform costs’. After all, everything revolves around transparency.
Han Dieperink is the chief investment strategist at Auréus Vermogensbeheer. He was previously the chief investment officer at Rabobank and Schretlen & Co. His contributions to InvestmentOfficer.nl in Dutch appear on Tuesdays. This column was originally published in Dutch on 25 July.
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