Eddie Irving wakes up at the crack of dawn every morning to tend to his begonias. A green thumb, the retiree enjoys starting the day early and reading the Wall Street Journal from his brownstone in a suburb of Queens. Irving, 74, retired from Con Edison over a decade ago, where he was an account manager and which continues to pay him a small pension.

And while he’s always had an interest in the financial markets, the high school graduate never felt confident enough to take an active role in the management of his money, preferring to leave it to the experts in Manhattan.

So when John “Jack” Bogle pioneered passive index investing in the 1970s, Irving naturally took to the new investment vehicle like a fish to water.

And as the popularity of passive investing rose, fees progressively came down, culminating in Fidelity Investments’s zero-fee mutual funds which were launched last summer.

At the time, pundits predicted a race to the bottom as passive investment vehicles competed with each other for market share, but the race to the bottom hasn’t yet happened or if it’s started, then participants look like they’ve pretty much taken a breather for now.

Despite the pressure from Fidelity Investments, the fees for index funds that invest in large U.S. corporations barely moved, according to a report by financial services giant Morningstar.

And in some cases, especially where funds were semi-passive or involved some degree of managerial discretion, fees actually rose.

Fees Matter to A Point

According to a worldwide survey of 300 institutional investors by Brown Brothers Harriman, one of the largest private banks in the United States, investors rated fund performance as important as fees for the first time in 6 years.

According to one pension fund manager,

“As yields are continuing to come under pressure, we’re looking more to value and performance. If the performance justifies the fees, we’ll pay the fees.”

“It’s not just about fees anymore.”

The sentiment marks a departure from the low-cost investing ethos that defined the passive fund management industry for over the last three decades.

And there are signs that even cost-conscious passive investors such as Irving, may be willing to pay a little more for strategies that can mitigate volatility, protect against drawdowns or offer steady income even in the face of especially turbulent markets.

The Race to the Bottom That Never Happened

Speaking to financial analysts at a conference last week, Robert Kapito, president of fund giant BlackRock said,

“Quite frankly, I think all of the fee wars that were going on — it’s stopped.”

But while passively managed funds have stopped slashing fees, their actively managed counterparts are continuing to slash fees on the back of lackluster performance over the past decade.

According to one boutique fund manager which specializes in technology stocks,

“I think you’re going to see a lot more (managers) flying coach and eating at Subway.”

“Costs are a major concern today.”

And it’s not just active managers who have had to tighten their belts, costs like trade commissions and financial advice have also come under pressure.

Passive investing has been at the tip of the spear in dragging down investment costs for the better part of a decade, but the poor performance of active managers who traded out their own alpha must also accept some of the blame for the wave of redemptions.

As investors piled into low-cost index funds and pulled out of expensive and underperforming funds running a variety of strategies from stock pickers to long-short funds, active managers have had to slash fees to keep up, with many closing shop altogether.

Long term passive funds have raised more money every year since 2010 than their actively managed counterparts and the reason, according to Morningstar, that investors paid lower fund fees in 2017, than they had ever done before.

But the pause in fee cuts in the world of passively managed funds suggests that the bloodletting has come to a pause, at least for now.

With yields coming under increasing pressure, passive investing, even at zero-cost is doing little for investor returns. Newer entrants into the passive investing market are bringing more sophisticated strategies and naturally expect to be compensated for it.

For now at least, it appears that investors are willing to pay so long as the price is within reason.

According to Ben Johnson, director of fund research for Morningstar,

“As people stop obsessing over fees, they’re coming to realize that what matters most is portfolio construction.”

And it is in portfolio construction that perhaps the most opportunity lies for active managers — particularly for alternative assets such as emerging market property, collectibles and even cryptocurrencies.

Alternative Asset Management is Expensive for Good Reasons

Whether it’s whisky or wine, classic cars or cryptocurrency, the plethora of alternative asset investments available to institutional and accredited investors is almost limitless.

But these investments don’t come on the cheap.

While managers in the passive and active investing space have been content to slash fees, managers of alternative asset investments have actually been gradually raising them.

According to one private equity manager based in Hong Kong,

“With some of our property development projects in Cambodia and Vietnam, we’re looking at perhaps 50% to 70% IRR.”

“So naturally our clients don’t balk at the higher fees. For them, it’s the cost of doing business.”

But naturally, given the higher rate of return, these investments are not without increased risk, or increased work on the part of managers for that matter.

Managers of alternative investment funds tend to have strong connections on the ground and the special knowledge and relationships required to navigate investments, particularly in emerging economies such as Cambodia and Vietnam as well as specialist knowledge in areas such as cryptocurrencies — expertise for which they expect to be compensated for.

According to some managers, fees can be as high as 5% for management and 30% of the upside — fees that investors in traditional capital markets would balk at.

And for cryptocurrency fund managers, the increased cybersecurity, fund management and insurance costs also mean that investors who are willing to delve into the new asset class have had to pay for the additional maintenance costs in order to participate in the higher returns.

But the rewards for investors who are willing to allocate a portion of their portfolios to emerging asset classes has been substantial.

Given the rise in wealth in the Asia Pacific region, investors, especially those with an appetite for risk and knowledge of local market conditions have been regularly seeing returns of 30% and above. According to one private investor, who runs a successful property investment firm in Singapore,

“I’m looking at a minimum of one-third (33%) returns. If I’m not getting those returns, I’m just not that interested.”

In contrast, Bridgewater’s Pure Alpha Fund returned 14.6% last year, while most other active funds were underwater.

Bridgewater of course also trades in a variety of markets, including emerging markets.

And because many high net worth individuals in the Asia Pacific region take a far more active role in managing their wealth, they are less constrained than pension fund managers and other institutional investors when it comes to asset allocation — allowing them the discretion to invest in anything from whiskey to cryptocurrencies, emerging market properties to cases of wine.

And because there’s no capital gains taxes in the financial centers of Hong Kong and Singapore, many of these alternative asset managers have been doing a brisk business out of the two cities.

So while fees may be higher for alternative asset managers, the returns are also substantially higher.

But given that most investors would not allocate their entire portfolio to an alternative asset management firm and even alternative asset management firms are well-diversified within their respective alternative assets, an astute investor could consider a risk-based active management approach, in order to decide whether or not to assign some of their portfolio to these higher fee investments.

At the end of the day, there’s a reason why fees are low or high and as the fund management industry becomes increasingly competitive and yields from financial markets come under increasing pressure, using fees alone to decide asset allocation is perhaps missing the forest for the trees.

Fees matter, but performance matters more.