Corporate advisers could bar providers from pitch exercises if they do not fully disclose performance-related fees paid on private markets investments.
This was a key issue for advisers at a recent round table debate, with many calling for more transparency around this issue.
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There was realism however, that the UK DC pension sector is not going to radically change market practices in a sector benefiting from global flows of money.
Advisers said no-one is asking for these fees to be dropped but they do want to see better disclosure and more flexibility.
Nigel Dunn, partner in the defined contribution team at LCP said: “The live issue we have got at the moment is disclosure. We’re had plenty of master trust selections over the past six months and not once did any of the providers quote what their performance fees were in their tender documentation.
“We have been pushing back, and they have said no-one asked us, or we will publish them in six months’ time, but we can give an estimate.
“We are getting to the stage of saying we are not going to put you in the selection exercise unless we know what the performance fees are, an estimate of what they have been since you’ve been running, and your expectation for being fully scaled up.
“Although they are not in the total expense ratio (TER), they are part of the costs. L&G has started to put performance fees on the fact sheets for their Lifetime Advantage funds. I would expect all providers to be doing the same, by the end of this year. That should now be the case across the board. We’ve been giving these providers an easy life.”
Aware of status
However, the panel understood performance fees could be necessary for access to the best managers and investment opportunities.
Roger Breeden, trustee executive at BESTrustees added: “We’d be arrogant if we felt that the UK DC pensions market couldoverturn years of operating models in private markets. There are other sources of capital, so, we need to be aware of our status in the market.
“The reality is performance fees have existed for many years. I don’t think we can say, this should be scrapped tomorrow, because those good deals will have performance fees attached. If you want those best deals, then this is something you’ve got to be able to tolerate.”
However, many felt discussions around these fees had evolved in recent years.
Jonathan Parker, head of defined contribution & financial wellbeing, investment consulting, Gallagher said:
“We are starting to see a willingness to be adaptable in how the fees are structured. Perhaps to keep the headline AMC within a level that’s palatable.” He added that across the sector ‘no-one blinks anymore’ when such fees are discussed. Three years ago he said they weren’t used at all due to regulation.
The discussion on performance fees was part of a wider debate about manager comparison, and on what basis providers might decide to use internal or external managers.
Compare the LTAF
Barnett Waddingham principal and senior investment consultant Gareth Doyle summed up some of the dilemmas facing advisers, using the example of the LTAF market.
“LTAFs specifically, are very different. If you get a bar chart and compare all26 it’s remarkable how different they all look, despite the fact the majority are meant to be used in the growth stage of a DC arrangement.”
Isio senior DC investment consultant Jacob Bowman added: “They bring governance complexity for reporting, rather than just one known fee that’s easy to measure against everyone else.
“If you’ve got someone who’s doing 70bps with a performance fee versus someone who’s doing 165bps with no performance fee, that’s quite difficult to compare.”
Sam Murphy, head of client solutions and product at Future Growth Capital added: “On the point about paying 70bps or 165bps, the experience that I have had is that going from a performance fee to a flat fee, you can’t necessarily access the same investments. We can’t do it in that structure and that actually will reduce your opportunity set.
“So, it isn’t a case of which do you prefer? It’s actually that if you want to play, these are the rules in which you will need to do it.”
He said that at FGC they look at fees across the portfolio. “We don’t want to be in a scenario where private equity returns 25 per cent and they charge their performance fee — and then private credit and real assets returns minus 20, for example.
“What we’ve done is keep the fee lower, and pay it away to managers. But we take the investment risk almost for the entire private market book. We think that transfer of ‘we’re responsible for the outcome’ is better. Notwithstanding, when you look at performance fees in private markets, you’re always toggling between different competing elements to try and optimise things.”
Breeden added: “It is going to be quite complicated, isn’t it? Maybe we should be giving the providers a little bit of latitude. They’re ramping up at the moment in terms of allocations [to private markets. So getting a meaningful answer to that question on fees is quite difficult. As a trustee, I’m in the same boat trying to say, what are we paying here and what’s the actual cost, year on year. It’s just going to be all over the
place to begin with. It’s going to take time for this to settle down.”
Those at the debate pointed out that performance fees don’t apply to all private market assets, and certainly not in private credit.
Murphy noted: “Not all private credit is created equal. You will have it in private equity, but in private credit if it’s a core type of mandate, direct lending, and it’s high single digit returns that may or may not have this fee. Some parts of private credit may have a 15 per cent return, and then it would have [this performance-related fee]. So, it’s about judging where are you getting bang for your buck.”
Conflicts of interest
Advisers have suggested that there may be conflicts of interest which arise from the need to keep costs down, although external specialist expertise was generally seen as a better option.
Doyle added: “Whether it’s managed internally versus externally, I’d have more faith using an externally managed or at least an appointed external fund-of-fund approach, when compared to internal [management], where perhaps they don’t have the resources, capabilities, experience to do it. That’s kind of obvious.”
Bowman added: “What starts to materialise, and where this fees’ point rears its ugly head, is that providers or LTAF designers are saying we need the price point to be low enough to get it into a default and not scare off the competition for our own trust or master trust book of business. How do they keep it low cost? They can use some of our internal capabilities because that’s cheaper.
“Is that the right thing to do? It might be because there’s obviously some very good in-house capabilities around the market, but it might not be.
“But if you’ve done it for a commercial reason you’re compromising on quality of managers or the quality of the asset allocation.
If your in-house capabilities are very focused on private debt, you might then put a lot more private debt in there than, say, private equity, which again, is kind of swings and roundabouts.
“What is right at the right time? That’s then when the fees start to come back in and drive the wrong decision making.”
Those at the discussion acknowledged that higher fees, and performance fees in particular would inevitably be a feature of DC investments, as schemes boost their private market allocations and target their Mansion House commitments.
But greater thought needs to be given as to how these shape investment decisions, alongside greater disclosure to consultants and clients.