Pensions in Switzerland: Cost wary could lose out
Next to no asset manager wants to be on the black list that the federal-level pensions supervisor (OAK), has created as part of the federal government’s structural reforms to the second pillar of the pension system. Each Pensionskasse must declare a total expense ratio (TER) for each mandate or fund, and must name each provider where a TER is not available, thereby creating a ‘black list’.
“We have achieved better cost transparency from almost every provider and nobody wants to be on the blacklist. This is something neither I nor our asset management team had expected to such an extent,” says Ronald Schnurrenberger, chairman of the board of the CHF9bn (€7.4bn) Pensionskasse PKE for the Swiss electricity sector.
An exemption from full cost transparency was created by the federal assembly for alternatives and structured vehicles that cannot give an estimate on their TER. But the last months have proved that any provider can report a figure useful to Pensionskassen, and the Swiss Structured Products Association is working on a calculation formula to be approved by the OAK.
“Suddenly things are possible, that have not been possible for years,” adds Schnurrenberger, whose fund reported an overall TER of 47bps on 98.6% of its investments. He says greater transparency has been possible because of the new legal framework, even given his pension fund’s size. The remainder was listed as ‘opaque’ mostly because the mandates are still in the pipeline. Among them are Asian infrastructure, real estate and a senior loan portfolio.
According to a survey by the Swiss pension federation, ASIP, at the beginning of 2014, the TER level of member funds averaged 43bps. However, including implicit transaction costs as well as estimates for structured products, cost analysis provider C-alm has calculated an average total cost quota closer to 60bps.
Similarly, Dominik Irniger, head of asset management at the CHF16bn fund for the Swiss federal railways, Pensionskasse SBB (PK SBB), reports higher cost transparency: “We have now also included costs for the lower layers in funds of funds in full and not only the top layer,” he points out. Irniger says PK SBB is not making use of the blacklist option, but obtains cost estimates from all providers to achieve full transparency. According to its 2013 annual report, the pension fund had a TER quota of 29bps.
Other funds have put providers on a ‘blacklist’ in their latest annual reports, the first that had to apply the new TER-regulation, but all industry representatives agree that this list will diminish. The cost transparency quota in the Swiss second pillar is already 98%.
But not all funds have been diligent. “Some Pensionskassen have avoided the effort of finding out TERs for all their investments and just put certain vehicles on the blacklist despite the providers issuing figures on costs,” notes Heinrich Flückiger, pension fund expert at Swisscanto.
Of course, some of the figures remain estimates and extrapolations, but even Ueli Mettler, partner at C-alm, agrees that the implementation of the new rules has “worked fantastically”, noting that all types of collective investment vehicle have issued transparent cost figures.
Earlier this year, Mettler warned against using too many estimates and extrapolations in calculating the overall TER level. He believes the new cost transparency regime will have an indirect regulatory effect on product offerings in private markets and funds of hedge funds, but without limiting Pensionskassen’s investment horizons.
Pierre Triponez, the president of the OAK federal level supervisor, is also happy with the acceptance of the new transparency regime. “All initial reservations have practically disappeared,” he declares, and thinks cost transparency makes “an important contribution to strengthening trust in the second pillar”.
Schnurrenberger says the TER calculation is not perfect, although it gives a good indication that is sufficient for boards to guide investment decisions. But, this is something he is worried about: “Some people completely forget that it is all about the return in the end and there is a danger the discussion is only about costs and TER.” He would have liked an analysis of net returns in the second pillar alongside the study into the asset management costs the government had commissioned from C-alm in 2010. Irniger agrees that “costs are not everything” and says that the net return always has to be taken into account.
According to Flückiger, few funds have taken the step of completely eliminating opaque investments, and only in cases where the net return was insufficient. Some were astonished about the level of costs of certain vehicles. “Many Pensionskassen do not have a problem with products with a high TER-quota if the net return is good and there are no comparable products at a lower cost,” he says. Mettler says a few Pensionskassen were surprised by their hedge funds reporting a high or excessive TER level, and the issue appears to be one of communication.
One area where costs might overrule investment decisions is the government’s proposed reform package Altersvorsorge 2020. In the initial draft, a cost cap on alternative investments was suggested, limiting them to one-third of the total TER. The draft is still under discussion.
Christoph Ryter, president of ASIP, believes such a cap is “more than superfluous”. However, he understands that the department of social affairs, the BSV, has seen that there are arguments against the cap and does not believe regulation will be forthcoming.
Jérôme Cosandey, director of the think tank Avenir Suisse, warns that a cap on alternatives would be tantamount to patronising trustees. “If investment regulations are tightened too far, everyone will choose the same asset allocation and no one has to think anymore”, he says.
Cosandey sees varying appetite for costlier alternative assets among Swiss institutions, depending on the risk profile, return expectations and investment horizon. “There are pension funds of cantonal banks that do not want alternative investments at all, but some public pension funds are using alternatives to achieve higher returns – fully aware of the higher costs,” he continues. “It should always be about a holistic view of the whole portfolio”, he stresses, adding that real estate investments are accepted because of their risk-return characteristics, despite the higher associated costs.
Overall, awareness of costs has been heightened, also among the individual pension fund membership. The issue has been dealt with by most pension funds now and they have gone on to worry about other legislative and regulatory changes, as Cosandey points out.
This perception was confirmed in a survey conducted over the summer by Credit Suisse. Just a third of Swiss pension funds said they were looking to cut costs. Nearly 40% said they had dealt with the issue, while more than 70% said they had already realised their full cost-cutting potential.
Many have done so not only by renegotiating fees and adjusting asset allocations but also by looking to claw back commissions to certain service providers. In its 2013 annual report, the PKE stated it had demanded back all of the commissions reported by service providers. The PK SBB already has agreements in place under which these commissions are automatically repaid to the pension fund. Last year, they amounted to CHF2.2m. In its annual report the fund only noted problems with one unnamed provider and negotiations about possible compensation for commissions received.
Aside from optimising agreements, trustees will have to remain focused on their long-term asset allocation and goals, however, in order to ensure that the debate on fees does not drown out sensible arguments for complex, and often more costly, asset strategies
Cost transparency: What Switzerland can learn from the Netherlands
The discussion on asset management costs is not limited to Switzerland. In the Netherlands, similar regulatory requirements have been in place for a couple of years, transparency is completely accepted now, and the discussion has moved to cost levels.
“When I take a look at the situation before 2008, many board members were a bit hesitant to make public what they paid for investment management services, but now most will agree they became more aware of costs and also provided other stakeholders with more transparency,” says Edward Krijgsman, principal at Mercer in the Netherlands. “Board members now take pride that they can report costs.” By law this also includes fees they pay investment consultants.
According to one senior communications specialist, it is important to disclose not only direct management costs but also the less visible costs in underlying funds and transaction costs.
In addition, asset managers in the Dutch pension sector agreed in 2010 a harmonised model to measure and report on total costs, which has improved transparency. Larger pension funds are likely to negotiate lower fees with external managers and administrators.
However, a recent survey by Lane Clarke & Peacock (LCP) on 230 Dutch pension funds showed that the two largest pension plans in the country, the €334bn civil service scheme ABP and the €156bn healthcare scheme PFZW, spent 69bps on average on asset management, whereas the other schemes paid 39bps on average.
While LCP did not establish a direct link between asset management costs and returns, the survey concludes that boards should provide more explanations of cost levels and strive to do more to lower investment fees.
But transparency may have had an effect on asset allocation. “Where appropriate within the asset allocation, the exposure to passively managed funds has been increased, while the allocation to certain complex investments with high cost structures has been lowered,” notes Geert-Jan Troost, senior consultant at Towers Watson in the Netherlands.
“Passively managed products have increasingly provided better insight into implicit and explicit costs,” he continues. “The use of structured products has to be considered also in the context of increased diversification, improving expected return, or a market opportunity”.
Larger funds invest more in private investments, which are more expensive than public investments and therefore the absolute cost level of larger funds can still be higher than smaller funds,” he points out. According to the LCP survey, the larger Dutch industry-wide schemes paid 21bps in performance-related fees last year while company pension funds spent 5bps.
As the sector has consolidated, the larger entities have reduced costs by switching from fund-of-fund vehicles to single fund or direct investments.
“Institutional investors worldwide are less prepared to pay higher fees for hedge funds and private equity,” says Krijgsman. “Not just the level of fees for these categories, but also the fact that performance during the financial crisis and the period right after has been disappointing, was an argument for pension funds to negotiate lower basis fees.”
How Swiss funds have achieved transparency
As part of the structural reform, §48a fig. 3 of the BVV law governing Pensionskassen investments was put in place to raise transparency in the reporting of asset management costs in the second pillar. The new paragraph did not give any details on which investment vehicles were to be included in the cost reporting and which cost figure was to be applied – this was left for the supervisor (OAK) to specify.
The Social Affairs Ministry (BSV) commissioned the consultancy C-alm to write an opinion on how to implement the new legal requirements, which it did in summer 2012, and “in effect OAK followed our recommendations”, according to Ueli Mettler, partner at C-alm. OAK defined collective investment vehicles as funds, fund-of-funds, Spezialfonds, hedge funds, derivatives on funds, structured products as well as private equity structures and non-listed real estate companies.
For listed private equity structures the supervisor notes that they only count among collective vehicles if they are regulated by a fund supervisory body.
The supervisor sets the total expense ratio (TER) as a default cost figure and lists other calculation concepts, which OAK accepts as equivalent. Each Pensionskasse now has to calculate a TER and all those vehicles where no TER was published or where Pensionskassen did not obtain a TER have to
be named in a so-called ‘black list’ in the annual report.