Disclosing full and consistent costs

Why shouldn’t we simply compare costs disclosed in financial statements? After all, they need to comply with accounting standards, right?

Wrong. There are two reasons why comparing disclosed costs makes no sense. First, funds generally disclose less than their full costs (and what they disclose is inconsistent). Second, even if we had full disclosure, straightforward comparisons are unhelpful and misleading.

Research completed by my CEM colleagues Sandy Halim and Mike Reid indicates that, at best, only half of total investment management costs are included in financial statements.

The research tells us that the average total cost of investment is 74.2 bps. This includes manager fees, internal costs, transaction costs and carried interest in private markets. Average reported costs were 37.5 bps.

The analysis is based on detailed cost data collected from over 300 global pension and sovereign wealth funds representing £7 trillion in assets and in particular, a subset of the universe who supply more detailed data and whose financial statements were reviewed for the study.

There are big differences from fund to fund. Some report 80 per cent or more of their true costs, others less than 30 per cent. One problem is that accounting standards provide room for interpretation and two funds with identical investment costs could disclose quite different numbers.

Which costs are reported most inconsistently in annual reports?

1. Pooled vs. segregated – Many pooled investment funds net fees from returns so the pension fund never receives an invoice and the cost never flows into the financial statements. Fees for segregated funds are typically invoiced and do show up.

2. Private market investments – Private market investments made through Limited Partnership agreements (LP’s) are particularly problematic.

· Base manager fees are often invoiced and reported after netting off ‘rebates’ in fees paid to the General Partner from portfolio companies. CEM believes that the amount kept by the GP should be included as an additional cost and the amount rebated to the LP should not be offset.

· Performance fees are always difficult and material. There is a difference between what’s paid and what’s accrued and there are many practitioners that still don’t regard the ‘carry’ as a cost.

3. Transaction costs - can represent 20 % of total investment costs and are painful to capture and quantify.

Why comparing from financial statements makes no sense anyway

Even if we had full and consistent disclosure, it would still be tough to make sense of cost differences. The true cost for some funds in the CEM database is below 10 bps whilst others are over 150 bps. Why is there such a huge difference?

Some funds are certainly more efficient than others, but the big differences are mainly explained by asset mix. More money in high-cost asset classes pushes costs up. Beyond asset mix, cost differences are explained by implementation choices, e.g., active v passive. Only when all those factors have been taken into account can we start to look at like-for-like fee comparisons on mandates.

For this reason, even if we had perfect disclosure, funds will still want help to make sense of their costs and to understand value-for-money.

The fact is that inconsistent and incomplete public disclosures mean that we simply can’t rely on financial statements as a source of truth on costs. Many funds are making genuine efforts to be clear and fulsome about what they spend. Those funds need to be recognised and appreciated – not to have a ‘high cost’ finger pointed at them simply because they are better at disclosing.