A recent trend in European occupational pensions has been towards increased transparency on costs – for instance, in the Netherlands and Switzerland. So for numerous European pension funds, measuring and presenting asset management cost data has become standard, even if the task seemed daunting for some at the outset. In Switzerland, managers unable to provide a total expense ratio are named in a separate ‘blacklist’ on the annual report.
Of course, the published figures come with caveats. Most funds with higher costs are running more complex, or illiquid, strategies, whose performance must be measured over a longer time frame, so simplistic comparisons are to be discouraged.
But the trend is definitely towards greater disclosure for members, even if awareness of the costs of strategies may lead to unintended consequences, like divestment from certain investments, such as hedge funds.
Indeed, costs were among the reasons for the decision of the Dutch healthcare fund PFZW to divest from hedge funds last year, which indicates the sensitivity of pension funds about fees in alternative asset classes.
A recent proposed legislative amendment in the UK would allow members of trust schemes to request details of voting behaviour and on the “selection, appointment and monitoring” of asset managers. As tabled, the proposal could even restrict non-disclosure agreements in asset management contracts, although trustees would have leeway around disclosure for “commercial considerations”. Although the government says it sees merit in examining the proposal, and is committed to greater transparency, there is little prospect of legislation before the May 2015 general election.
Many trustees would fight greater transparency and have no wish to disclose external managers, let alone fee terms. And while total expense ratios or comparable cost figures are easy to grasp at the level of the fund overall, the relative basis point fee differential between active developed and emerging market equity mandates, say, is not likely to be of direct interest to most DB fund members.
But if most members do not require look-through to the level of costs of individual mandates, the current level of opacity around fees really only benefits the vested interests of the asset management industry so a compromise is inevitable and indeed, there is certainly a sensible debate to be had about the level of transparency that is appropriate for pension funds towards members.
Those in pure defined contribution funds bear the risk and the cost of the investment and therefore they have an absolute right to cost transparency. Those in defined benefit or hybrid schemes, where they bear some level of risk, also have a right to information about how their contributions are being invested, although there is no industry benchmark or standard as to what they should be permitted to know. The problem is one of time horizon, since the outcome of a long-term investment strategy can by definition only be known in the long term.
Is it possible to predict the future success or failure of a pension investment strategy? Returns and costs are individual data components of that strategy, which itself is a component of the overall strategy of the fund. This includes both contribution inputs and as benefit outputs; in isolation, return and cost data are informative but should not be mistaken for the strategy itself.
The overall governance of the scheme, including the skills and experience of the trustee board and the executive management team, is probably the best predictor of long-term results. Greater transparency goes hand in hand with a holistic understanding of objectives, strategy and outcomes.