The clear cost of investment

As the FCA asks schemes to name and shame opaque managers, how do transparent disclosures move from compliance into meaningful action?

Obscuring investment costs is becoming a risky game for the asset management industry, and Dr Chris Sier knows it.

Now several months into a commercial cost-gathering venture with Clearglass, the long-time transparency campaigner and chair of the Financial Conduct Authority’s institutional disclosure group is using his regulatory contacts as an added weapon in his armoury.

Constrained by confidentiality from reporting recalcitrant fund houses to the FCA himself, he says regulatory executives have instead asked directly for trustees to name and shame the “less than 10 per cent of the asset managers who just say no” to requests to supply cost data.

“I spoke to the FCA and they have asked me, ‘Will you tell us who the managers are that are not giving data’,” he says. “I can’t do that… but I know who can give them that and that’s the clients.”

From there, the FCA’s approach seems to rely more on soft persuasion than any hardened regulatory threat. But this could be about to change, if pensions and financial inclusion minister Guy Opperman gets his way.

Welcoming the formal launch of cost-reporting templates published by the successor of Dr Sier’s working group, the Cost Transparency Initiative, the minister last month told the industry: “High fees can eat into savers’ pension pots and add to employers’ costs. This initiative will help pension schemes take a holistic view of costs and charges as they strive to ensure their members get value for money.”

There are managers on that list who struggled to give me data both on the operational level and the emotional level
Dr Chris Sier, Clearglass

“I’d strongly encourage trustees and investment managers to embrace the Cost Transparency Initiative and adopt the new templates,” Mr Opperman said, following up with a stark threat: “The Government will legislate robustly to make this happen if the industry does not resolve this on a voluntary basis at speed.”

In fact, Dr Sier says this is not necessary, as the pressure now exerted on managers by their pension fund clients and intermediaries has meant that market forces can now take over.

For example, Clearglass and its more than 40 pension fund clients have ensured compliance from over 120 asset management companies so far. With the company about to sign contracts with two large consultancies, the pressure on the six currently refusing will only increase.

“The thing I like about voluntary is that it tells you who the good ones are and who the bad ones are,” he says. “To me the signal of saying no tells me a lot about that asset manager.”

“When only 5 per cent of the managers are saying no, I don’t think legislation is necessary,” he adds.

Greater transparency across the globe

So has the investment industry’s problem with opacity been put to bed, with asset owners and fiduciaries now able to judge value for money easily?

Well, not quite. For one, there is the question of how to respond to the minority of managers that still refuse to submit cost data to clients.

“Fortunately, raising the threat of the FCA sanction is enough to make most managers fold, however there are still six that just don’t get it,” says Dr Sier.

There are also those that appear to be selective about when they are forthcoming with data, attempting to limit disclosures to only UK funds, or even solely to the Local Government Pension Scheme.

The LGPS Scheme Advisory Board publishes a list of around 100 asset managers and investment pools that have signed up to its code of transparency, a template reporting structure that was a predecessor to the CTI.

“There are managers on that list who struggled to give me data both on the operational level and the emotional level,” says Dr Sier. “At least one... flat-out refused and they shouldn’t be on that list.

“It’s indefensible for a manager to give data in this country and not to give data in another jurisdiction,” he adds, hoping that the CTI introduction will start a global move towards greater transparency.

Buffett takes aim at private equity

In some corners of the asset management market, charging structures are such that even fellow investors have labelled them egregious.

A prime example is that of private equity, which attracted the ire of celebrated investor Warren Buffett last month.

Bloomberg reports that the Berkshire Hathaway chairman told attendees at the firm’s annual meeting last month: “We have seen a number of proposals from private equity funds where the returns are really not calculated in a manner that I would regard as honest.”

Buffett and vice-chairman Charlie Munger took aim at general practitioners excluding money yet to be deployed from performance measures, and warned against the leverage used to pump up returns.

Adopt direct approach towards unyielding managers

Dealing with opaque managers will require trustees and consultants to get tough with their managers. Dr Sier takes a typically direct approach with those managers that remain obstinate.

“The world order has changed. I’m not asking for the data, your client is... you’re going to lose the mandate,” he says. “You’re a crook because you haven’t given the cost data which describes your relationship.”

However, he adds that this refers to a minority of cases. For most managers, transparent culture is merely taking time to filter down through the organisation.

“The relationship manager who we generally get put in touch with by the pension fund often doesn’t understand the strategic imperative,” he says. A manager might be publicly supporting the struggle for transparency, but in some cases “the truth of that is that that doesn’t filter down”.

He adds: “I have to find a way to get in contact with the most senior person… when I eventually speak to that person the unblockage happens.”

We have got some significant concerns that the data will not be correct or fit for purpose at the first pass
John Simmonds, CEM Benchmarking

The UK’s largest pension funds appear to be taking this approach already.

Mel Duffield is pensions strategy executive at the Universities Superannuation Scheme and also chair of the CTI board. She says the USS has not encountered any problems obtaining cost data disclosure from managers. While she declines to say whether the USS would terminate mandates with obstinate managers, she insists commitment to transparency will be a key feature of its tender process, rewarding managers who engage.

“We would expect to receive information around the disclosure information the asset managers are able to provide,” she says. “I think it will be very difficult for asset managers to say they’re not engaging in that process at all.

“We haven’t had challenges so far in terms of our asset managers completing [the DC Workplace Pension Template for transaction costs], so we’ll be able, in July, to disclose that information. I’m aware that experience across the industry may not have been so positive.”

The direction of travel in favour of compliance with the CTI seems undeniable, but this does not necessarily mean the data will be useful.

First, the disclosures have to be correct for trustees to then make meaningful use of them.

John Simmonds, principal at CEM Benchmarking, says: “We have got some significant concerns that the data will not be correct or fit for purpose at the first pass; some of it will, some of it won’t.” Data cleansing is a time-consuming task, as anyone in pensions administration knows.

If trustees do establish that they have been presented with incorrect figures, they will want to hold their manager to account over the failure in some way.

Rightly so, says Mr Simmonds: “It’s the pension fund’s money – these are costs that are being met on behalf of the pension fund members.

While schemes are likely to compare their costs to a peer group in the first instance, questions also hang over whether asset management margins as a whole are too healthy.

The FCA’s asset management market study found in 2016 that the fund management industry was the second-most profitable sector in the UK over the previous 10 years, with its average margin of nearly 40 per cent beaten only by the real estate industry. Across the FTSE All-Share, average operating margins were around 16 per cent.

Demand for sustainable investing practices has delivered a shot of good governance however, with managers including M&G and Jupiter joining a shareholder revolt against pay packages at rival Standard Life Aberdeen.

Dr Sier says the sector will not be too keen to crush its own margins, despite the “irony of asset managers voting against the compensation packages of the assets that they hold”.

Trustees must decide on flexibility

Richard Butcher, managing director of professional trustee company PTL and chair of the Pensions and Lifetime Savings Association, says: “One of the flaws in the CTI templates, and it isn’t a flaw of their own making, is that in relation to the transaction cost element they’re going to allow asset managers to disclose using the slippage-cost methodology.”

Schemes must also decide how much flexibility to give managers about how to present data. The prioritisation of risk management over returns will have to be balanced against the danger that asset managers are allowed to return to their old ways.

Some would say that allowing asset managers flexibility about how they report their performance and costs is what has got workplace pensions into the mess in the first place.

Private equity is one such example. The industry’s insistence on reporting internal rates of return and calculating fees from this measure, despite the fact that no clients receive this, has attracted criticism from other market players, including Warren Buffett.

The CTI is currently looking at how to adapt its templates for liability-driven investment managers, with Ms Duffield suggesting that there is “further work to do” to help schemes make sense of their allocations.

Meanwhile Dr Sier is considering how templates might better help esoteric hedge funds taking long and short positions explain their benefits, but stresses that this can only be an add-on.

“I’m not into allowing them to present the data in a different way. They have to make sure there is like for like comparison between different asset classes,” he says. Where managers do present a compelling case for adding an asset class-specific measure, “it’s always in addition to the core data”.

Identifying a fair price

Scrutiny of investment costs is likely to spur innovation on charging in the asset management industry. In 2018 for example, Close Brothers Asset Management introduced an all-in fee structure, taking on responsibility for variations from the fixed charge, with the exception of transaction costs and third-party funds.

Dr Sier is not keen on this particular development. Few schemes have ever collected this level of information, so are powerless to decide what a fair all-in price is.

“You don’t know if the all-in fee… is the same as the previous fee that you were being charged in the round, and I want to know that information.”

To take meaningful portfolio action a fair price has to be identified, but how exactly do schemes arrive at this figure?

“We’re only just getting disclosure, so most trustees haven’t thought about how they’re going to convert that into a value assessment,” says Mr Butcher.

The first option would be to conduct an absolute assessment, drilling into the true costs of delivering asset management services and determining whether fund prices accurately reflect this – a process Mr Butcher describes as “very difficult to do”.

Instead, industry consensus has settled around more feasible objectives in relative comparisons – comparing asset classes, fund managers, and even pension schemes themselves, against their peers.

The first step should be to make a comparison between the risk and return profiles of different asset classes, says Ms Duffield. “Over time we may then start to see benchmark services establishing themselves.”

Should we tell members?

Pro-transparency regulation in the UK has focused on delivering information about charges to members as well as fiduciaries. The Department for Work and Pensions’ rules for defined contribution transaction cost disclosure, for example, require that members be signposted towards a cost information online link in their annual benefit statement.

However, there are doubts about whether charge information is of any use to members, especially given that default savers can only ask their employer to change their arrangement.“The information that’s being requested in the CTI templates is very much around good governance, and there is a level of detail that would go way beyond what your average member would want,” says Ms Duffield.

Meanwhile some suspect that DC disclosures will amount to little more than a data dump.“The charges that [DC providers] apply will vary from fund to fund but they can also vary from employer to employer because they operate in a competitive environment,” says Mr Butcher, who insists members should only see a statement from trustees confirming value for money.

“They could have to disclose something like 7,000 lines of data showing the costs and charges and that’s just not going to be a meaningful exercise.”

Should we tell members?

Pro-transparency regulation in the UK has focused on delivering information about charges to members as well as fiduciaries.

However, there are doubts about whether charge information is of any use to members, especially given that default savers can only ask their employer to change their arrangement.“The information that’s being requested in the CTI templates is very much around good governance, and there is a level of detail that would go way beyond what your average member would want,” says Ms Duffield.

Meanwhile some suspect that DC disclosures will amount to little more than a data dump. Mr Butcher says mastertrusts “could have to disclose something like 7,000 lines of data showing the costs and charges and that’s just not going to be a meaningful exercise.”

Tough questions for active managers

Uptake of templates has been promising so far, according to the various types of intermediaries operating in the sector. But wider adoption will be needed to allow true comparisons between schemes on asset mix-adjusted performance, cost, and ultimately value for money.

“That’s one of the stumbling blocks of this,” says Mr Simmonds. “Ten datasets is not going to do it.”

But even if data is not ubiquitous enough to make detailed comparisons against a peer group for all types of schemes, comparison of asset classes against each other could make a meaningful difference to portfolios.

Particular scrutiny is likely to be applied to actively managed funds, which in some asset classes have struggled to justify their already high fees.

Dr Sier says pre-template disclosures typically cover a third of the types of fees actually charged. If active funds are seen to be hiding costs in these categories they could see further outflows.

Robin Powell, an advocate of passive investing and editor of the Evidence-Based Investor, says: “Transparency will bring into much sharper focus the substantial price discrepancy between active and passive funds. I suspect institutions will be shocked in particular at the difference that transaction costs make.

“Generally, active funds trade far more often than they should, and the impact on net returns is considerable,” he continues. “Thankfully, fund trustees are finally starting to realise how much better off they are avoiding active funds, and hedge funds in particular. I’m hopeful that greater transparency will accelerate that trend.”

Private market funds will also face some of the toughest questions. “The big driver of cost within most, particularly defined benefit pension funds, is private markets, and that’s the area where it is particularly difficult to get data,” says Mr Simmonds.

Few reliable benchmarks exist for comparing private markets and esoteric investment styles, although investors do have the option of comparing actual returns with public markets.

That is complicated somewhat by the lag in private market valuations compared with their public counterparts. “What you’re seeing in public markets today is likely to be what happens in private markets three months hence,” says Mr Simmonds.

He highlights private market funds of funds as a sector under threat: “The more layers there are in the onion in terms of costs then the more difficult it is to justify.”

However, he sounds a note of caution to predictions that a low-cost revolution is brewing: “There’s a power balance, and a lot of it is ultimately vested on the side of the fund manager,” he says. If schemes pull their money from the most popular funds, “there are no shortage of investors ready to step up to the table.”