Winter, it would seem, has come early(ish) to the south of England. Whilst I’m not exactly freezing as I sit and write this latest blog entry, there is a nip in the air that reminds me of home, north of the border. I need something to warm me up, and it doesn’t need to be made with peaty water and come out of a bottle labelled ‘Laphroaig’. What would be a good topic for this latest instalment in my take on things LGPSi to get the blood going? How about fund management costs? This is something that some of my fellow 151 bloggers seem to have turned to recently, and it’s sure to be a topic to warm the cockles of any self-respecting LGPSophile’s heart…..oh, the inefficiency of the LGPS as it stands is simply staggering……..
Hang on a minute - is this inefficiency real or perceived? As ever, the devil is in the detail.
And are there some relatively simple actions that LGPS Funds could take to address some of the concerns? Possibly, and it thankfully doesn’t involve the wholesale restructuring or merging of the LGPS, contrary to what some commentators might suggest.
For the casual, and not so casual, reader of LGPS Fund Annual Reports, one area of interest amongst many is costs, and more specifically the cost of carrying out the investment management and pensions administration related activities for Funds. The £ figure per member is, it would seem, regularly bandied about to show which Funds have ultra-low costs (good), and which Funds have sky high costs (bad). Conventional wisdom would then seem to indicate that the expensive Funds should be ‘sorted out’ and made to look more like the ‘good value’ Funds. Let’s merge ‘em all – that’ll sort the problem out, and let’s forget for the moment about the individual governance and funding arrangements of each Fund. Big is beautiful!
All well and good, but what happens when we scratch the surface of this issue? Pensions administration is not my area of expertise, so I’m going to – as usual – focus on the investment management side of things
Why would some Funds appear to be more expensive than others? Here’s some possible reasons that spring to my mind:
1) Complexity of investment arrangements – many, many LGPS funds spend a great deal of time and effort on their investment strategies, and as a result may have a very diverse approach to investing, which leads them into ‘fee heavy’ areas such as Private Equity, Hedge Funds (single strategy or Fund of Funds), Active Equity mandates, and Diversified Growth Funds. Should Funds such as these really be penalised for trying to reduce risk and enhance returns in their overall strategies? Perhaps their view is that an increase in fees of, say, 40 basis points, may well result in enhanced investment returns or, perhaps equally important to them, a marked reduction in estimated investment return volatility, or event contribution rate volatility.
2) Less passive – some Funds out there still believe in active management, and would rather take a view that good managers exist, and should be given the opportunity to demonstrate their skills. Should they be penalised for taking this view? Surely it’s true that the more investors go passive, the greater the opportunity for non-passive investors in such markets, as stock prices are at the end of the day driven less by index positions and rebalancing and more by, well, the fundamental factors that actually determine the value ofcompanies? I have great sympathy with investors who want to buy a stock because it looks like a good investment, rather than because it’s part of an index.
3) Limited room for manoeuvre – it is true that a £50 million Unconstrained Global Equity mandate will have less immediate fee pricing power in the market than, say, a £300 million one, and as a result the smaller LGPS Funds would seem to be at a disadvantage. There’s little that could be done about that – until now. More on this in a moment.
4) Incomplete information on display – is all true ‘fee’ information easily and readily captured? How many pooled fund investment fees are missed from the total expense calculation because they are not paid by invoice – and therefore would not constitute an explicit expense - but slip off the radar because they are charged internally in the pooled fund itself? What about, as another example, Private Equity fees contained in limited partnerships? Are these expenses shown? Again, the Funds that disclose everything are shown to be more expensive than their peers, and as a result incorrect conclusions can be drawn about the stated cost of running pension fund investment arrangements.
5) Timeframe – can anyone sensibly believe that absolute management costs should be assessed over a year? Or even three? Investment strategies are set with the longer term in mind, and so the cost versus benefit of having these strategies should also be measured over the long term, but with on-going oversight.
What can be done about these examples that can make some Funds seem to cost more to run than others? Well, a bit more understanding, and a bit less criticism would be good for a start.But also, consider the following:
1) As recommended in Lord Hutton’s reports, Funds need to provide more financial information that allows for a reasonable comparison between them, in terms of their strategic investment goals, the assumptions they use in setting their strategies, and their views on reducing risk (and indeed naming the risks their seeking to reduce)
;2) A common sense acknowledgement that less in the way of passive will mean more in the way of active, with the understanding that such a position is being taken in the hope that an additional investment return that exceeds the extra fee paid is achieved;
3) Framework Agreements – a perennial favourite topic of mine, and so I won’t say much more other than collective bargaining doesn’t need to come at the expense of local accountability for Funds;
4) Funds need to sense check the fees that they pay, versus the ‘universe’. This could be done in a number of ways, for example: - DCLG collating all investment management fee information from each LGPS Fund and providing feedback directly to Funds as to where they sit in the fee ‘spectrum’; - Funds working together, as I know some already do, by sharing their fee experiences in local CIPFA/NAPF groups; - Fund’s asking their investment consultants to compare the fees they currently pay versus the consultant’s wider client base fee experience; or - an independent third party collecting all fee information from Funds, and essentially doing the same as the DCLG in my point above, but with this third party being beyond the scope of any FOI requests that might seek to access the fee information; and
5) Be patient!
Are there problems with my ‘solutions’ above? You bet. Are they valid observations that might add to the debate? I hope so.We don’t need to merge LGPS Funds to make life less expensive. Funds can - and do - work together to try to solve this problem, but it will require a greater degree of openness to someone. Asset managers may not like the direction of travel I’ve suggested on fee comparisons, but it’s in their interests too that the investment arrangements of the LGPS are fair and sustainable in the long term.
I'm busy working on my blog posts. Watch this space!