Achieving value for money involves more than simply being the cheapest, says AllianceBernstein head of pension strategies David Hutchins
Independent governance committees (IGCs) and trustees are required, as part of their remit, to provide value for money. There is no real definition of what constitutes value for money, but the initial focus at least appears to be on overall fees and charges. While I fully endorse this desire to protect employees from high or unfair costs, in asset management our fiduciary duty of care extends to achieving best execution. As a result, we believe that factors beyond paying the lowest possible fee for investments need to be taken into consideration.
Indeed, value for money in our minds is about achieving best member outcomes, net of fees, over their lifetimes in a scheme. For this to be achieved, we believe two key steps are necessary – identifying the budget spent on investments versus administration, and measuring outcomes at the member level.
To ensure that these steps are implemented, we believe regulators should be pushing for greater transparency on the part of providers on both issues. With few exceptions, we find little transparency in the market today: Significant levels of transaction costs go unaccounted for, occurring at the individual member level as fund switches are implemented by administrators rather than by fund managers, who are required to disclose their performance net of such costs.
Furthermore, performance reporting of the overall default strategy as experienced by members over time, net of all transaction costs and changes in underlying components, rarely occurs. Indeed, reporting is often limited to the current components of the default strategy, rather than that of the overall strategy.
Discussions around the investment budget rarely focus on answering the key value for money question of “could we achieve better net outcomes if we spent more”.
As such, plans often state they are better because they are cheaper, rather than making value statements around the quality of their investment offering and what they expect it to deliver – and what it has delivered.
Achieving value through the best possible strategic asset allocation seems obvious, but many members don’t realise that, typically, only around 10 to 25 per cent of the cost budget is spent on investment. As investment product fees also account for fees on other services underlying the funds, such as administration, it seems to be generally assumed that more is spent on managing the funds.
But this is not always the case and the value for money debate would, therefore, benefit from greater transparency around how charges break down for schemes. As part of good governance, we should be explaining to members exactly where their money is being spent. Trustees aiming to deliver value for money will see if they are only spending five basis points on investment and 70 basis points on administration. More importantly, they can then decide if it might be more in the interests of their members to spend, for instance, another five basis points on investment to enable greater diversification.
Without this debate, we are currently seeing too much emphasis on a very limited range of the very cheapest passive strategies. These may preclude effective risk management and opportunities to grow by accessing a broader opportunity set.
Of course, tracker funds have generally performed well in the rising markets of the past five years. But, as conditions change – and we believe they will – a more dynamic approach will become essential.
Members expect us to respond to volatility, such as we saw in August. Investors need to shore up their defences in advance of the storm and to keep a lookout for the first signs of dark clouds on the horizon. In today’s market environment, even long-term investments such as pensions need to be monitored and managed on a daily basis. The days of “set and forget”’ in pensions are long gone.
Despite my concerns about how value for money is interpreted and put into practice, I remain optimistic. In a value-driven regime, it won’t be viable to sit back and simply buy the cheapest option. I believe that IGCs will adopt a smarter approach that measures performance against member objectives and takes into account a wider range of strategic asset allocation factors.
