Two years ago, the Financial Conduct Authority published a damning assessment of asset management groups, due to the opaque charging structures being levied on pension schemes. Remedies put forward from the 2017 Asset Management Market Study included a standardised template for disclosing costs and charges, a working group to assess the suitability of benchmarks for judging performance and the proposal to adopt a single ‘all in’ fee to investors.
A consequence of this critical regulatory assessment was that corporate advisers and pension schemes became much more keenly interested in what they were being charged. For some pension schemes it has led to a sizeable investment in resources to monitor the costs being levied on them by managers.
In September 2019 the Local Government Pension Scheme (LGPS) hired tech firm Byhiras to build a cost monitoring platform for its 100 member funds. In an announcement to members, the group said funds within the scheme would now be able to compare costs and performance in a standardised way for the first time.
“LGPS funds will benefit from a range of reporting tools which enable them to make best use of the cost and performance data provided,” Roger Phillips, chairperson of the LGPS scheme advisory board said.
The increased scrutiny of costs by pension schemes is by no means an isolated consequence of the FCA’s study. Also in September, 10 of the UK’s biggest pension schemes, collectively managing some £150 billion in assets, wrote a letter of support of a new set of standards on fees and charges, drawn up by the Cost Transparency Initiative. The CTI wants pension trustees to urge asset managers to report their costs in a standardised format, beginning from the current year-end.
Counting the cost
However, asset managers have previously warned that an over- zealous focus on cost alone could lead to some pensions dumping outperforming managers because they demand a larger fee for their expertise. They claim that weighing up costs in isolation from fund performance, and without taking into consideration the asset class, will lead to worse outcomes for the end investor. Cheap does not necessarily mean ‘good value’, they claim. But consultants don’t agree. Altus head of retirement strategy Jon Dean says consultants and advisers rarely mistake price for value when evaluating investment funds for pensions.
“Independent governance committees appear to be working well to balance the member value assessment between costs and quality,” he explains.
“Fund fees are clearly an important area of focus, however, the auto-enrolment fee cap is already preventing the worst excesses. Instead, committees are paying attention to the appropriateness of the default fund to the scheme’s membership and typical at-retirement journey, as well as the quality of scheme communication, online access, retirement options and customer service.”
Dean also challenges the view that paying more to an asset manager leads to better outcomes. “There appears to be no evidence that paying higher fees for investment management reliably results in higher long-term returns to a pension fund,” he told Corporate Adviser.
“The FCA has uncovered clear evidence that, given sufficient scale, a scheme could make substantial savings through use of a segregated mandate fund, with charges on average more than 45 basis points lower than for active retail funds.”
This point was echoed in an October report by consultancy group bFinance. The research entitled Investment Management Fees: Is Competition Working? noted that “the investment management industry is not one in which price competition functions efficiently, and the factors inhibiting or encouraging price competition vary considerably by sub-sector.”
Winning the price war
One consequence of greater scrutiny of investment costs is that asset managers have had to respond. The bFinance report shows that costs in several asset classes have been on a downward trajectory since 2016.
Asse t manag er s ha v e substantially reduced what they charge for absolute return bond funds, emerging market equities, emerging market debt funds and fund of hedge funds, according to the research. More modest eductions in fees can also be witnessed in global equities mandates.
“Price has been an easy metric to compare value against and has had the desired result of improving pricing from the different providers,” explains Redington head of defined contribution and financial wellbeing Lydia Fearn.
“However, because of this, providers then have their own profit margins squeezed and this can mean a reduced spend on other areas such as communications or technology. Therefore, it is vital we consider value across the whole proposition, and not just the price members pay.”
The issue of value is a tricky one, however, as it seems that fund managers haven’t been slashing fund fees across the board. The bFinance report shows that some asset classes in the market have yet to see any reduction. In alternative risk premia funds, for example, fees have remained roughly at the level seen in 2016, while private markets have proven to be a difficult area for advisers and trustees to compare costs.
Private markets have been a noteworthy growth area for fund groups over the past two years, in terms of assets under management. The research found that fees may have nudged downwards in areas such as private debt, but found that pricing in illiquid investment has been “obscured by the complexity of structures.” This has meant that a decline in the management fee is often offset by lower hurdles, higher fee tiering thresholds and higher “non-fee” costs, once again highlighting the difficulty that schemes face in weighing up value.
Achieving good value
Redington’s Fearn says that the most important thing for advisers to remember is that the member outcome is critical when assessing value.
“Advisers and employers should set a target for their members and determine whether they remain on track or not,” she suggests. “These calculations should include the costs members pay as well as the investment returns.”
So, does this means that pension schemes should perhaps consider spending a little more on investments than they are at present? Fearn says that this question is overly simplifying what is a much more complicated issue.
“It is not as simple as [saying] pay more for investments, as members should feel they are getting value which should in turn be reflected in their outcomes.
“For example, you may put a new active fund into a default strategy only to find it effectively acts like an index-tracker but costs considerably more. This is not value for money. Understanding the overall strategy and selecting the right funds and fund managers for each part of the journey is more important that just spending more on investment.”
Another way identified by the FCA to achieve better value is to achieve ‘scale’. Of course, this is easier said than done. For smaller pension funds operating in isolation, they may be paying substantially more for certain asset classes by accessing them through retail funds, rather than benefitting from lower costs on offer through a segregated mandate.
Therefore, schemes have been urged by regulators to consolidate, if possible, into master trusts or pooled mandates. Doing so, could also make accessing more esoteric asset classes more viable.
“Segregated mandate funds cost, on average, 23 basis points,” explains Altus’ Dean. “With larger scale, you can begin to incorporate infrastructure and other less liquid assets as part of the mix, to take advantage of valuable long-term income streams.”