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Impact Investing

IPE special report May 2018

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It’s a question

An overwhelming majority of pension fund managers use investment funds for part or all of their portfolio but many are uncertain about whether they are getting value for money or not and there is a wide diversity of opinions about what they expect from the fund managers. Like some airline passengers, many seem happy with what they are paying until they find out what the person next door is being charged

In this month’s Off The Record, we asked pension fund managers about their use of investment funds within portfolios.
While most schemes go the funds route for a portion of their assets, many might be advised to shop around or get on the phone to fellow scheme managers to check exactly what they are getting for their money.
The overwhelming number of Off The Record respondents – 87% – use investment funds in one shape or form, although some qualify their use, noting that they are brought in to look after peripheral investment such as emerging market exposure. One manager notes: “Funds are only used where our investment manager has insufficient knowledge or the assets are too small for a normal spread.”
For those pension schemes not investing through funds, most cite size, a preference for direct investment or use of indexation as negating reasons.
Those operating via funds tend on average to have around 33% invested, although the range of investment portions stretches from some with less than 1% to those fully invested in funds.
And it seems the main reasons for choosing to invest through funds is that great comforter – the ability to get hold of your money with the minimum of hassle. Two-thirds of respondents cite administrative convenience and a further 60% point to ease of access as their main motive for fund investment.
Less than half claimed funds were used for any tax-efficient status. Other advantages mentioned include the ability to carry out effective manager selections, style diversification and low fees.
For some pension funds, size dictates what they can and cannot do, as one respondent explains: “We use funds because some specialist mandates are easier to access for smaller plans in these mutual funds.”
In terms of the type of funds used, there is little doubt open-end vehicles are the market driver. More than 90% of schemes say they pool their assets, whereas only 20% indicate they go it alone in closed-end funds.
Funds based in tax-favoured locations also – perhaps unsurprisingly – garner good interest with 60% of schemes claiming usage. Passive/index funds are also popular with investment made by over two-thirds of respondents. Forty per cent of schemes also say they invest in retail funds.
However, while the multi-manager and fund of funds trend may be the hot topic of debate at the moment, actual interest from pension plans is still rather lukewarm, with both only appearing in 7% of respondents’ fund structure.
On average the amount of assets invested by pension plans in mutual funds comes out at a sizeable e63m, although the range goes from the larger fund users, investing upwards of e100m, down to the smaller dabblers in the e1m fund exposure bracket.
And it would seem that a minimum figure to put into a fund is a moot point, with one manager stating they would not invest less than e50m in a mutual fund and another noting investment of only e10,000 in one fund.
One thing is certain, though, amongst institutions. That is that being a bulk investor in mutual funds should guarantee the right price from the fund proprietor; not one dissenting voice was heard when asked whether institutions expect favourable fee rates from their fund managers.
That is not to say fund managers are going to bankrupt themselves for their business and 87% of scheme managers acknowledge they have to sit down and negotiate a deal on fees. A handful note, however, that they have a fixed fee arrangement with the manager.
On the whole, payment is the least satisfying part of the deal for any buyer – and this is no less so for pension fund managers – particularly if they are being asked to pay twice. Consequently, only a third say they invest in funds with an initial entry fee.
Furthermore, those who do lay down tight conditions for their use. As one manager says: “We will use entry fee funds but only those with a maximum fee of 0.5% where the investment is not available anywhere else. They can give access to otherwise unobtainable markets.”
Fewer managers still want any deal that sees them reaching for the wallet when they want to leave a fund or get their hands on their assets with only 27% using funds with an exit fee or early redemption charge.
Surprisingly though in these days of comprehensive, globally accessible information, there is a wide disparity in expectation over how much schemes should pay for investment fund management of their assets. Differences in market practice and the number of suppliers around will inevitably feed their way into the fee structure.
As one reply states: “I can’t rally answer the question of fees sensibly because I am responsible for more than 50 funds in 38 different countries and fees vary wildly.”
On average for domestic equity funds plan sponsors expect to pay around 0.4%, although this ranges from one fund saying it pays 0.09% and another parting with 0.75%.
For domestic market indication the average payment of 0.0725 is rather more uniform.
However, the further away from home a scheme seeks to place assets the wider the range of fees they seem willing to pay appears to be the case.
In actively managed European equity funds, for example, while the average expected payment came out at 0.84%, this included variations between 25 basis points (bps) and 300bps in possible fees.
Notably, the disparity is larger in payment for indexed European equities with payment expectations ranging from 0.0095% to 0.5% with an average of 0.16%.
Interestingly though US equity fund charges gained a greater fee consensus with active management averaging 0.7% and passive 0.175%, only marginally greater than average European equity fund charges. The disparity trend re-establishes itself for Far East equities though (active – 1.06% average, passive 0.27%) and also for emerging markets (active 1.13%, passive 0.44%).
Perhaps ‘market forces’ are truly at work here in that schemes will pay what they believe is the going rate for fund investment until they discover their next-door neighbours are paying less for the same goods.
More importantly, is information on fee charges as comprehensive as it should be?
For fixed-income fund investment anticipated payments are less dispersed, with domestic fund charges averaging 10bps, Eurozone 12bps and international fixed-income funds charging 30 bps, according to averaged-out responses.
Could greater use of consultants be the answer here? Certainly this is not yet the norm, with just under half of respondents seeing fit to employ an adviser at present.
It would seem though that the majority of schemes may have reached their limit on fund investment – only 27% say they are seeking to increase assets in investment funds in the future. Those that are cite greater diversification as their goal for the most part.
However, a large number of funds point out that as they increase in size they are looking to the direct investment route and greater implementation of segregated mandates.
Some are adamant that this is the surest means of control: “We prefer segregated accounts and a global custodian to maintain a birds-eye view of our investment and to enable aggregated risk control,” says one scheme manager.

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