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UK pension funds split on Dutch proposal to penalise underperformance

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UK pension funds have given mixed views on calls from two of Netherlands’ largest schemes to penalise asset managers for poor performance.

PFZW, the pension fund for the care and welfare sector, said it wanted to see punishments built into contracts to trigger a fall in fee levels when managers underperform.

ABP, the public sector fund, backed this assertion and suggested it wanted to work together with PFZW to formulate a plan.

The chair of the £5.7bn (€6.9bn) Pension Trust, the industry-wide fund for UK charities, waded into the row by calling for greater alignment between managers and clients.

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Sarah Smart, chair of the trustee board, told IPE that if managers were carrying out work intended to benefit their clients in 10-15 years’ time, bonuses should be structured for a similar term.

“We have bonuses and long-term incentive plans being paid after three years,” she said. “I don’t understand why bonuses cannot be deferred even when an executive has left the company.

“At the moment, it is possible for managers to bank long-term fees on an annual basis, but if everything crashes after five years, they still get to keep the money.”

Smart said performance fees needed to be properly structured to align remuneration with the long-term effects of the investment strategy.

The radical reformation of manager fees to better suit clients’ interests have been mooted before, and not only by asset owners.

Kirill Ilinski, co-founder of hedge fund Fusion Asset Management and a former options trader at JP Morgan, reckoned performance fees ought to be escrowed until a client redeems, and the whole amount remains at risk to cover losses in the meantime.

The manager then, not the client, always takes the first loss as long as there is cash left in escrow.

But another major UK pension fund’s in-house manager selector doubted that performance fees were the answer for long-only active managers at all.

The selector, who asked for anonymity, said that a sharp move would distort the market.

“By shifting the commercial risk towards the managers, you would probably lose a lot of niche players from the field. The big houses would soak up the extra cost, but is that what we want?”

The source said performance fees generally were to be avoided: “Why would you want to pay extra? When it comes to fees, we are realists.”

Steven Robson, head of pensions at United Utilities for its £2bn fund, agreed, and suggested that penalising underperformance could lead to different behaviours negative for the fund.

“If you are looking for a high return for higher risk, then underperformance penalties could make the manager more cautious, and possibly more likely to meet the benchmark but less likely to meet the performance target,” he said.

“Manager fees should be set with the aims of the fund in mind. Performance or underperformance fees are fine as long as these are set at a level that should align the behaviour of the manager closer to the aims of the fund.”

Barry Parr, co-chair of the Association of Member Nominated Trustees and director of the Orange Pension Scheme, supported the contracts, but said an agreed floor – to ensure the manager can survive – would be necessary.

“Otherwise, they could theoretically lose all concern,” he said. 

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