How Can Trustees Ensure Value for Money?
bfinance insight from:
Frithjof van Zyp
How can pension fund trustees provide effective governance on the subject of cost? Ensuring value for money is central to fulfilling fiduciary duty. Yet this remains a challenging and opaque subject, where overly simplistic comparisons and metrics can do more harm than good.
Following the publication of bfinance’s 2019 Investment Management Fees study, a group of superannuation fund officials gathered in Sydney to review key findings and discuss their own experiences of assessing, managing and improving costs. There was a strong consensus among all participants on two points: that investment management fees are still fairly opaque and that, while fees are only one part of the value equation, the subject will continue to be a key area of focus for the Australian Government and the Regulator (APRA).
Indeed, the scrutiny on this topic has become yet more intense with the development of APRA’s new ‘heat map’ illustrating the total costs for the country’s super funds as well as their five-year returns. The metrics are somewhat crude: five years is often not long enough for a costlier strategy to ‘pay off,’ especially if those five years fall within an equity bull market. Yet they are increasingly powerful and here to stay – for industry comparison, for client decision-making, and for trustee governance. In addition, fees are one of the components that APRA expects the Trustee to measure and comment on as part of the Prudential Standard on Member Outcomes.
How useful is fee benchmarking?
While various providers (bfinance among them) provide benchmarking services that help pension funds and their trustees to gain clarity, roundtable attendees shared mixed views on the quality of research they’d encountered in this area.
First and foremost, it is important to compare like with like. Not all strategies bearing a certain label are the same, while other variables such as mandate size, required specifications and client type can also play a role.
Trustees should clearly understand the purpose of a fee benchmarking study and pick the type of analysis that will best support that purpose. Is the intention to offer “validation” for the status quo, showing that existing fees are competitive, or is the goal to support “renegotiation”? Depending on the source of the data (investor or manager? survey or tender?) and how it’s analysed, one can provide a very different analysis on the same costs.
Personally, we believe that basing data on fees quoted by managers in live tenders provides investors with the maximum firepower for renegotiations. This provides conviction that the comparators are relevant to the particular strategy and mandate, while avoiding the price-inflation found in manager fee surveys. An approach based on live manager search activity is also more likely to reveal newer dynamics, such as an increased willingness to drop price in certain strategies.
Note: a Real Estate Debt case study from our new “Lessons from Manager Selection” paper neatly illustrates the difficulties of comparing fees across different geographies, with Australian managers charging lower visible fees but skimming off “establishment fee” revenues that their international counterparts pass onto clients. Click Here to find out more (pages 4-7).
Becoming an MVI (Most Valuable Investor)
One of the most popular topics for discussion among superannuation fund roundtable participants was the subject of the investor’s “worth” to the manager they may appoint – understanding it, maximising it and leveraging it in order to maximise bargaining power.
Managers trying to develop an Australian client base
Australia, with its large pool of superannuation monies, is highly attractive to asset management firms. Yet the “worth” of an Australian superannuation client will be particularly high to a manager that does not have a substantial client base in the region and wishes to develop one. The acquisition of a sophisticated local investor raises the manager’s credibility and appeal to others in the same market.
Clients of “emerging managers” also have high value: an investor that is an early adopter of an investment manager is worth a lot to that firm. Yet there are obstacles to accessing this segment, even for investors that are permitted by their investment policies to consider managers with shorter (<3 year) track records. Agency issues can be particularly relevant: many investment consultants avoid reviewing managers with short track records, focusing limited research resources on firms that will have the broadest client appeal. Yet investors can address these problems: stronger governance, more internal resources for manager research and engaging other consultants may be helpful steps.
Size and influence
The consolidation of Australian superannuation schemes is potentially helpful in terms of increasing bargaining power. In the first place, a larger size gives the opportunity to issue larger mandates – clearly linked, for certain asset classes and size thresholds, with lower fees. In addition, the investor inherently becomes a more desirable “high potential” target, particularly for managers that offer a range of potentially suitable strategies, increasing their influence at the negotiating table.
Can fees fall further?
The latest bfinance data indicates fee reductions in a number of asset classes and sectors – particularly in areas which are somewhat newer or undergoing a fundamental shift in competitive dynamics. Yet how much further can price compression continue in the most established and popular asset classes, such as active global equities?
Roundtable participants, broadly, shared a consensus view that many investment managers operate with very healthy profit margins and, as such, that there’s still room for fees to decline without excessively squeezing the managers. There also appears to be a prevailing opinion that investment managers are, by and large, retaining scale benefits when assets under management increase rather than sharing these benefits with clients. That being said, some did highlight exceptions such as managers offering loyalty bonuses (a reduction in fees based on length of time that the investor has been in the strategy).
Another argument in favour of future fee reductions is the perception that there is still a great deal of inefficiency in the system caused by a lack of standardisation. Multiple participants expressed the view that certain aspects of asset manager usage could and should become more standardised. One helpful example is the ASFA guidance on IMAs, which was welcomed by this group.
Harnessing the power of competition
It is clear that fees will remain high on the agenda in Australia, as is the case in many other markets globally. Trustees expect scrutiny to continue and must provide strong governance on costs, ideally without sacrificing the quality of investment strategy and implementation to the detriment of stakeholders.
In bfinance’s view, the key to cost reduction is competition. Price competition in asset management is still weak relative to other sectors. This stems from several factors: the lack of transparency on fees and total costs, the narrow shortlists often used in manager selection, the tendency to leave fee negotiation until the final stage of a manager search process, to name a few.
Competition can be enhanced, or even engineered. Manager searches can be conducted in ways that maximise competition – and price competition. Since regular tenders are not always desirable, fee renegotiations can introduce an element of competition by proxy if the right information is used. Competitive forces can be maximised when the investor truly understands their value to the managers they are considering.
Trustees seeking to govern costs within their institution should seek to understand – and harness – these forces to their advantage.
This commentary is for institutional investors classified as Professional Clients as per FCA handbook rules COBS 3.5R. It does not constitute investment research, a financial promotion or a recommendation of any instrument, strategy or provider. The accuracy of information obtained from third parties has not been independently verified. Opinions not guarantees: the findings and opinions expressed herein are the intellectual property of bfinance and are subject to change; they are not intended to convey any guarantees as to the future performance of the investment products, asset classes, or capital markets discussed. The value of investments can go down as well as up.
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