The ‘what’ and ‘why’ of costs
Controversies around pension funds’ asset management costs in various countries tell us something about the mood of the times, but they also suggest that changes are needed in the way pension boards select and justify their strategy choices to members and the wider world.
Recently there have been debates about costs in the Netherlands and Switzerland. In the UK, the auto-enrolment charging cap of 50 basis points for default funds has been controversial, but it is the continuation of a downward trend in costs for end users.
The general debate around bonus culture and the alignment of interests between the finance industry and asset owners is, of course, shaping many of these debates. In the Netherlands, some pension funds are working on new remuneration models in areas like private equity.
Hedge funds have also been in the limelight: fees, or rather value for fee dollars paid in relation to of investment outcome, were also one of the reasons cited by CalPERS in its decision recently to divest from hedge funds.
Elsewhere, a strong ownership culture is driving the debate and in Switzerland and the Netherlands the debate on fees is partly due to the fact that pension funds are compulsory with a captive membership.
Public pension funds are often singled out, as is the case with CalPERS, or the City of Zurich pension fund, where there has also been a debate on the costs related to its hedge fund investments. In public schemes there is a natural imperative to keep the cost to the public purse to a minimum.
In the case of the UK, auto-enrolment will continue to drive the focus on costs for the end users, although some asset managers assert that the cap is too low to achieve good outcomes in terms of dynamic asset allocation: you shouldn’t expect too much for 50 basis points, they say.
In the UK, there is also an on-going and related debate on the utility of active management; moving wholesale to passive management is one of the serious policy options for the 89 local government pension schemes in England and Wales, which together manage £180bn (€227bn).
What are the implications for pension fund boards of these debates? Trustees will have to think about the ‘what’ and the ‘why’. The ‘what’ involves transparency about cost data in annual reports and perhaps even in member statements. This might have to drill down into the level of different asset classes.
The ‘why’ is more complex and has implications for governance procedures and processes. If boards come under fire for excessive costs or for selecting particular asset classes, they may need to point to evidence to justify the choice of assets.
The focus on costs is good and to be welcomed, but it should not drive pension funds away from making asset allocation decisions that are in the long-term interests of their member.