Challenge on Fees, or Lose Money, Investors Told

(July 1, 2013) – The sticker price for investment management fees is more like an opening offer, according to MSCI data on post-negotiation payments.

Even for similar-sized mandates within a specific strategy, fees varied significantly from one deal to the next. Furthermore, MSCI found “very little, if any,” correlation between performance and fees with the majority of mandates.

Fee dispersion—the spread between fees paid at the 90th and 10th percentiles for mandates between $50 million and $100 million—topped out with large cap core managers, at 50 basis points. Small cap core came next with 45 basis points, while large cap value fees were one of the most consistent, with a dispersion of 23 points.

Corporate defined benefit plans showed more variation in the fees paid than did public defined benefit plans, according to the report. Large cap core managers, for instance, had a fee dispersion of 54 basis points with corporate pension clients, and 42 basis points with publics.

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Jim Morrissey, CEO of MSCI’s reporting arm, called these findings “contrary to popular views,” and promised further investigation into the relationship between fees paid, investment risk, and portfolio construction.

The indexing and analytics firm based its conclusions on a database of 34,000 institutional fee observations for live deals. The most popular strategies recorded were all for equity managers. Out of 31 strategies examined, large and small cap core, all cap core, and small cap growth had the most robust data sets.

Related cover story: Who’s Paying What

(July 1, 2013) — The UK’s lifeboat for bankrupt company pension funds knows it can fail, and how-and the ways in which it could happen may be unexpected by most.

With this weekend’s news that the Pension Protection Fund (PPF) is to take over a failing company for the first time-UK Coal-and its pension liabilities, the focus is ever-more acute on what could sink the institution that was created to save members relying on payments in retirement.

Commentators have claimed the lifeboat could be sunk by too many companies coming under its protection or demands on its finances being too high. After a thorough “reverse stress test”, it appears it is not the assets these commentators need to worry about at all, but the much less straight-forward “human element” that could capsize the PPF.

Lucy Currie, an actuarial practice leader at the PPF, was tasked with finding out under which scenarios the institution could-and would-fail.

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“We looked at what a successful PPF was, and what could go wrong,” Currie told aiCIO after presenting a paper she co-authored on the study last month. “We looked at the definition of failure and realised there was no single one. There were various routes, including reputational and political issues, but none of them were financial.”

The PPF, which is on course to become one of the largest funds in the UK, is vulnerable to the investment behaviour of UK pension plans. In the (somewhat unlikely) event they all move to the same asset class mix, which proves to be toxic, and they subsequently all end up under the auspices of the institution, the PPF would have a problem. But this would not automatically constitute a “failure”, according to Currie.

“We have the option to cut payments, we are not subject to Solvency II type regulations, and the reality is, what we identify as ‘failure’ could occur a long time before insolvency,” said Currie. “We fail when our stakeholders say we fail.”

She, along with a team from consultants and actuaries Milliman, set about interviewing a range of these stakeholders at the PPF. This ranged from the press relations and human resources departments to board members at the institution. Across a series of meetings, the team built up a cognitive map using the responses they gathered that showed the routes to failure.

“We talked about specific scenarios to make it real for stakeholders so they could draw on past experiences,” Currie said. “It was also a good way to validate what we are getting right.”

The map used the same language as had been reported in the stakeholder interviews, as the results had to be meaningful and relatable to all parties.

These responses fed into “critical nodes”, an impact upon which could trigger a tipping point to failure for the PPF.

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The six scenarios identified included staffing and administration issues, or outside forces impeding the institution’s proper function.

“We worked back and looked at how they could all happen,” said Currie. “We created something that would feel real for the board and ran a ‘scenario day’.”

The scenarios identified were not just present day potential failures, but also looked to the future.

“We looked at underlying issues that pervade across the entire organisation,” said Currie, “and we did not identify any new risks. We did made new connections to how scenarios could occur, however-the board was reassured.”

The exercise offered new insight if not new risks, the team said, and made connections between the “owners” of the risks and those with power to monitor and manage them.

“The openness of participants was critical and we were surprised how excited people were to take part,” said Currie.

The PPF has around £16 billion in assets and is growing through investments, levy payments from UK schemes, and pension transfers, but carrying out this type of exercise is not just for the largest institutions, Currie argued.

“The interviews took a couple of weeks, and Milliman needed about the same time again to create the cognitive maps that we could assess. If there was anything missing from the discussions, we can clearly see in the map that is produced,” she said. “It’s good to get back quickly to interviewees and keep them engaged.”

Currie encouraged other funds to carry out a similar exercise, regardless of asset or organisation size.

“It’s repeatable for other funds and is a useful driver of change in risk culture,” said Currie. “Even if there is just one person responsible for the pension, they can do the analysis and raise their own awareness; it is very difficult to do without structure.”

As the Solvency II-type regulation has been seemingly shelved for European pension funds, eyes have turned to the parts of the IORP Directive that focus on governance.

Might it be time for all pension funds to carry out a similar exercise, if only to comply with regulation?

To read the entire paper, click here.