Dutch funds are now required to provide deeper insight into their expenses in their annual reports
• Dutch pension funds must provide look-through reporting on transaction costs from the 2017 accounting year onwards.
• This will be complicated for asset classes such as property and private equity, and for closed-end funds.
• There are worries that the overall picture will be incomplete and that pension funds with legitimately high costs will come under pressure.
Pension funds already pay attention to transaction costs in their annual reports. Usually the reporting is limited to stating the entrance and exit fees charged by the investment funds. However, the internal expenses costs at the investment funds – largely for purchase and divestment of securities during the year – are not yet being reported.
This will change as of the current accounting year, as the recommendations of the Dutch Pensions Federation prescribe that pension funds must provide a full look-through of their transaction costs. The result must be stated in the annual report for 2017. Pension fund boards are currently consulting their fiduciary managers and asset managers.
The €10bn pension fund of telecoms provider KPN has been working with its fiduciary manager TKPI to get an insight into transaction costs of their investment funds: so-called funds for joint account for equity, fixed income and property. The manager, TKPI, in turn issues underlying mandates to asset managers for investing in pooled assets of pension funds.
“Through this approach, establishing transaction costs in equity and fixed-income funds is relatively simple,” says Jan-Maarten van Osch, trustee at Pensioenfonds KPN and chairman of its investment committee. “TKPI already knows the transaction costs, as it has an insight into the transactions of asset managers. Expenses in fixed-income funds could be estimated based on the spread.”
Unearthing transaction costs at non-listed property funds is more complicated. “We have tried to get more clarity last year, but we didn’t succeed for all funds. The problem is that reporting separately on transactions isn’t common practice for property managers,” says Van Osch.
“When a real estate manager buys a property, he will account the prime costs and communicates this to the participants in the investment fund. However, the manager won’t usually divide these expenses across, for example, purchase price and transaction costs. To get an insight into the transaction costs, TKPI has asked property managers to fill in a form. However, the outcome varied and was not satisfactory.”
Van Osch explains that this was largely thanks to differences of interpretation between the managers about in filling in TKPI’s forms. “It is about 30 managers with their individual reporting systems. Therefore, it is not easy to get everyone on the same wavelength.”
After some adjustments and improved guidance, TKPI has asked the property managers to provide the data for the first half of 2017. It says it would analyse the information during the summer to determine whether it was on the right track.
The €4bn pension fund of the supermarket Ahold also expects the first reports from its managers during the second half of this year. “We work closely together with our fiduciary manager AXA Investment Managers,” says Eric Huizing, executive trustee.
Until now, the Ahold Pensioenfonds has published all transaction costs of its investment mandates as well as purchase and divestment costs of the funds it is invested in. It does not yet mention transaction costs within the seven investment funds. Huizing says he nevertheless expected few problems of getting clarity about these costs: “The transactions costs are available at our asset managers. A problem could be that fund managers must produce the information in a way they are not used to. But I doubt this would require a large effort from them.”
Over 2017, the Ahold scheme will only report on transaction costs of its equity and fixed-income funds. Currently, it is divesting its remaining stake in private equity and non-listed real estate. Huizing indicated, however, that he can imagine that pension funds with a considerable exposure to private equity and non-listed investment funds, will struggle to provide a full look-through.
Does the effort to make all transaction costs transparent outweigh the scale of these costs? In 2016, the KPN scheme’s transaction costs were 0.03% of its average assets under management. The pension fund acknowledges that these did not represent total transaction costs.
In the opinion of both Van Osch and Huizing, it is useful to have an insight into these expenses. “It enables us to compare asset managers as well different investment years. Large deviations must be explained and could be a reason for further investigation,” says Van Osch.
He made clear that he was worried about how outsiders would deal with pension funds’ reports. “Transaction costs are likely to be compared, and there is a danger that schemes with the highest expenses will be highlighted in a negative way.” says Van Osch. “The other possibility is that pension funds that have put in most effort in specifying their costs, also show the highest expenses. But if other pension funds don’t provide an in-depth look-through, there won’t be a proper comparison.”
Huizing also sees a comparison problem. “Higher transactions costs could be caused by a pension fund’s deliberate choice for a more active investment policy. An active investment fund trades more, automatically incurring more transactions expenses. This is not negative per se, but the consequence of its policy.
“Another example of why transaction costs could differ is the extent to which pension funds rebalance at year-end,” Huizing points out. “If a pension fund only rebalances its investment portfolio once a year, it would incur lower transaction costs than a scheme that adjusts its allocation on a quarterly basis.”
Eric Veldpaus, founder of IBI Benchmarking, cites a further obstacle for cost comparison. “Pension funds are allowed to use different methods for establishing the spread of bonds, such as the real spread per transaction, the average spread over the past quarter as well as a standard spread that applies to the market. As a result, pension funds could report different expenses over the same transaction,” he explains.
Huizing says pension funds themselves are responsible for providing adequate data for a fair comparison. “If you claim to be transparent about transaction costs, you also need to clarify your approach and the assumptions you have used.”
Veldpaus says that, despite extensive guidance, he doubted whether pension funds could provide full clarity about transaction costs. “Fund managers affect the financial markets with their orders. As a result, orders are usually processed by brokers and market makers against a price that differs from the price at the moment the order was placed. This market impact also applies to transaction expenses.”
Pension funds, however, do not have to factor this aspect into their report and Veldpaus says he has sympathy for this approach. “Calculating the market impact is not impossible, but very complicated. It makes clear that transaction costs at pension funds are much more difficult to compare than costs of asset management.”
Van Osch of the KPN Pensioenfonds says: “Reporting transaction costs in the annual reports over 2017 should not be the tailpiece, but the start of a discussion about transaction costs within investment funds.”