In his review of UK institutional investment, published in March, Paul Myners drew attention to the lack of scrutiny of transaction fees, particularly broking commissions, incurred on clients’ behalf by their fund managers. Myners was concerned that trustees receive little information and have little control over these costs; the lack of transparency means managers have little incentive to put pressure on broking fees. He was keen to align the interests of managers and their clients.
The UK government recently published good conduct principles for UK pension schemes and annexed 10 questions that trustee boards should present to their managers to initiate a debate on the transparency of transaction costs.
Embedded within this subject is an implicit attack on soft commission and commission re-capture arrangements. It is clear from statements made by Myners that he believes neither would exist in a world of perfect efficiency. Institutions appear split. It is easy to agree that the major transaction costs which funds suffer relate to market impact and stamp duty (on UK equity purchases). Should we worry about an additional 2–3 basis points of commission costs used to support soft arrangements, an amount that is often lost in the noise of managers’ relative performance? Further, soft commission, if disclosed to clients, is an activity that is acceptable to the UK regulatory authorities.
Managers may use soft commission for different purposes. Some use it to finance the cost of performance measurement for funds they manage. However, some use the rebate to pay for investment services. This might include specific economic or company research, but managers have also disclosed payments for datafeeds such as Bloomberg terminals. One has to ask the question why any of these services should be purchased out of clients’ assets rather than forming part of managers’ core infrastructure which they should finance out of their own pockets.
Myners produced a table illustrating the average annual costs paid to various parties involved in providing services to institutional investors. For a typical scheme with £200m (e324m) assets, the fund manager receives 27bps and the broker 15.
A soft commission charge of 2bps is 7.5% of the 27 basis points paid in managers’ fees. And, these are fees rather than profitability. Those managers who use soft commission to support their profitability would suffer considerably from the removal of softing arrangements.
It is arguable whether the management of pension funds has been a major generator of profits for UK investment managers. Against a background of reduced asset values on which their ad valorem fees are calculated, profitability will come under increasing pressure. We can expect to see a considerable amount of bloodshed when the accountants start cutting away the corpulence that amassed within investment houses over the bull years of the 1990s. I cannot see trustees being terribly sympathetic to any personnel fallout which results because they feel little personal alignment of interest with their highly paid investment managers.
John Hastings is a partner in the investment practice of Hymans Robertson, part of the Milliman Global network

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