A $550 billion money manager is testing a new strategy as it fights back against cheap ETFs - and it could be the future of asset management

AP

• AB's chief executive officer said new funds that offer cheaper fees if they don't beat the market could entice individual investors to try actively-managed strategies again.
• The active space has seen billions of outflows, as investors favor cheap ETFs.

AB, a $550 billion manager, is betting it can win back individual investors who have abandoned active products, such as mutual funds, in favor of lower-fee passive funds.

The New York-based manager's solution is a hybrid model of the strategies, one that the industry may be slow to replicate, said AB's CEO.

"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."

Managers including AB and Allianz Global Investors have launched these hybrid funds, which charge fluctuating fees based on performance, in the last year to compete with low-cost index funds and exchange-traded funds. These passive products charge much lower fees than their mutual fund counterparts and have largely outperformed active strategies, leading investors to abandon them en masse.

Active funds saw $58.8 billion of outflows in the year ending September 30, while passive funds drew in $510.1 billion over the same time, according to Morningstar research.

Earlier this year, New York-based AB launched six products under the FlexFee Funds umbrella. The actively-managed strategy sees fees change based on one-year performance: when a fund underperforms a benchmark, investors pay low fees akin to those of an exchange-traded fund. After outperformance, fees increase, up to a cap.

Bernstein said that managers of such fulcrum funds sacrifice some performance fees compared to managing purely active products, a hurdle for investment managers considering the strategy.

"I for one am not really surprised by the industry's resistance to doing it," he said. "It's hard to predict where it's going. I think it makes sense for us, though."

Other managers in the space include Allianz, which launched a suite of products in December. At least 10 managers are considering the strategy, according to an executive who has met with interested companies. Would-be managers are monitoring inflows to current fulcrum funds before launching their own, the source said.

"It's going to take time," Bernstein said on Monday. "We've been really consistent in saying this is a multi-year rollout for us."