There are three fundamental questions that pension fund Boards should expect answers on:

1.     Are my costs reasonable?

2.     Am I getting value-for-money?

3.     Am I becoming more efficient?

In the first of three articles we focus on question #1 – are my costs reasonable?  

The starting point is to work out your total cost. The CTI templates will help, but you will need templates from every manager and all of them will need to be accurate. That may be achievable in public markets, but private asset cost data is much more difficult to obtain. You should expect some gaps and inconsistencies and have a plan for making the data ‘whole’.

Once you have a total cost number, you can start to think about whether your costs are reasonable. The most sensible way to do this is through a

peer-based benchmark comparison. 

The starting point is to select the peer group. It is important to get this right because it defines the question you are trying to answer. For example, are my costs reasonable for a fund of my size and with my assets? We therefore need to find a peer group that helps you to answer that question. We also need peers that organise their data in a similar way to you.

If you have a high-cost asset mix then your total costs will be higher, so we need to adjust for differences in asset mix. This means taking peer costs at an asset class or mandate level and applying them to your asset mix, i.e., what would your costs be if you handed your assets to the peer group to invest based on their experience? 

Comparing your actual costs with the benchmark tells you if you are high or low cost compared with peers. This is helpful but to make the analysis actionable you need to understand why. There are two drivers:

1.     ‘Implementation style’

Implementation style is about the structural decisions that are made in implementing the strategy. It is about passive v active, internal v external, use of overlays, and how you go about investing in alternative assets.

These are factors within management’s control and therefore should feature in the benchmark comparison, i.e. a fund that invests passively should generally show as low-cost compared with a fund that invests actively. (There is a separate issue of value for money that we will address later).

It’s sensible to put a cost on each implementation decision. Doing so helps you to understand the cost impact of your choices, for example ‘you saved £1 million relative to peers because you invested more of your assets passively’. Conversely, it’s helpful to understand the cost ‘drag’ from being active and to look at that in the context of performance.

2.     Paying more or less than others

Once we have understood and quantified the impact of implementation decisions then we can focus on whether we are simply paying more or less than others for similar assets / mandates. 

There are a number of parts which can be considered and compared individually but it’s also important to add them together to get a complete view:

·       Base fees

·       Performance fees

·       Fees embedded in pooled funds

·       Transaction costs

·       Internal and other oversight costs

In comparing with others and looking at the individual components, we can drill down to identify managers and mandates that might be of concern and start to put the spotlight on those. Often there are good reasons why costs for some mandates might be higher.

One of those good reasons is clearly better performance. That is why looking at cost in isolation is unhelpful. In the next article we will pull the threads of cost and performance together in order to measure value-for-money – did paying more get you more?

John Simmonds, Client Relationship Manager