Hyperbole around investment costs has the potential to drag trustee boards down a rabbit hole at a time when they really need to stay focused and strategic. I say this as someone whose business is helping pension funds make sense of their costs – so what’s the story?

First of all, don’t let me lull you into a false sense of security. Costs matter. They are important in DB pension schemes where every £ taken out in fees ultimately needs to be put back by members, employers or taxpayers. They are more important still in DC schemes where every £ that is taken in fees reduces the members pot. Over the last 20 years two thirds of the value created through active management by funds in the CEM Benchmarking global database has been consumed by cost. I will say it again - costs are important.

The question however is how much time trustee boards should spend looking at their costs?

Great boards stay focused on the big picture. By and large, costs should be looked after by the management team and boards simply need comfort that management is doing its job, boards simply don’t need to scour reports that compare costs at a detailed level. So, what do they need, and how often?

An annual check-in will be sufficient for most – any more than that is likely to mean the board is too far ‘into the weeds’. More important are the questions trustee boards should be considering within this annual review, I suggest there are four key questions:

 

1.     What are my total costs?

It seems so simple and yet, for many funds just understanding what they are spending is difficult. The Cost Transparency Initiative (CTI) templates are one way to capture data, but for funds with private market exposure the data is still difficult to obtain – and it’s in private markets where the big costs lurk. For some boards just knowing how much is being spent in investing their assets is revelatory.

2.     Are my costs reasonable?

Knowing what your costs are is one thing, understanding if they are reasonable is another entirely. Boards don’t need a line item breakdown; they just need comfort that their total costs are reasonable and to make sure that the management team is focused on getting the best value for the fund. 

One way to get comfort is to compare with other funds, to do this you need data. 

Looking at financial statements doesn’t cut it though, what is disclosed publicly is generally not fit for purpose. At the same time, when you have comparator data, just comparing headline costs is misleading and unhelpful. You need to adjust for asset mix differences, and you also need to account for the different approaches that are employed in implementing strategies, e.g., active v passive, internal v external. Only then can you make a judgement about whether your costs are in line. 

3.     What’s happening to my costs?

Trend analysis is the next crucial step. It’s one thing to understand how you compare, but direction of travel is arguably more important still. As your asset mix changes, so too will your costs. If you invest more in high cost asset classes, your total costs go up. 

With that in mind, it’s important to look beyond the headlines and distinguish between cost changes driven by asset mix and underlying changes to what you are paying for the same assets over time. It’s also important to pick through the impact of performance fees, boards should be looking for increasing efficiency rather than headline changes.

4.     If I’m paying more, am I getting more?

Ultimately boards need to know if they are getting value-for-money. If they are paying more, are they getting more? Any analysis of costs needs to go hand-in-hand with an analysis of performance. In particular, active management ought to be rewarded by outperformance relative to sensible benchmarks (otherwise why invest actively?). Value added over and above sensible strategic benchmarks is a good yardstick.

These four questions seem simple and yet collecting and interpreting the data needed to answer them is anything but.  

Just because it’s difficult though doesn’t mean it shouldn’t be done. After all, isn’t it incumbent on boards to ask the difficult questions?

John Simmonds, Client Relationship Manger