Is the balance of power shifting from asset managers to trustees?

Trustees are learning to get bolshy over contracts

Stephanie Baxter

As trustees demand better terms in investment management contracts, Stephanie Baxter asks if schemes are now calling the shots

At a glance

  • Trustees are negotiating harder on investment management contracts
  • Fees are easier to renegotiate than governance structures
  • The more schemes that demand better terms, the harder it will be for managers to refuse


Negotiating terms of contract with asset managers has always been an arduous task for trustees. Many hear the excuse, ‘if we change it for you, we'll have to change it for all our clients'.

Legal costs of analysing contracts rigorously during the selection process can rack up quickly and may deter schemes from pushing too hard. But the tables are turning as trustees are demanding much more from managers. So is the balance of power switching to schemes?

Squire Patton Boggs partner Judith Donnelly says: "Schemes have always had the power but they're increasingly willing to use it. It's the funds that negotiate and actively monitor their managers that get the best terms. Managers are more willing to address concerns as more schemes want a partnership approach and greater transparency."

Investment management has become increasingly competitive, meaning keeping hold of clients has never been more important. The shift from defined benefit to defined contribution is accelerating this. Since the crisis trustees have also been more wary of financial services providers, especially when there is less capital around than before.

Power to the trustees
BESTrustees chairman Alan Pickering says: "In an era of low returns, both in real and nominal terms, people are looking at the detail of the investment managers' appointment contracts to make sure there are no hidden charges, no unjustifiable fat."

There is a growing awareness that the headline fee is only a portion of the total amount paid, so schemes are negotiating more on fee structures to limit the negative impact on performance.

"The ability to charge expenses has been very broadly drafted and there has been very little oversight, particularly in alternative investments such as private equity," says Donnelly.

Fee negotiation is just one part; there are other areas where more attention is being paid, such as ensuring conditions in contracts are balanced fairly.

"There are a number of clauses that try to protect the fund manager against activities often outside their control or our control and it strikes me that they seek to achieve an unfair level of protection," says Pickering. "Having discovered this in newly negotiated agreements, a number of trustees like me are going back through old contracts to see if we've nodded through things in the past that we wouldn't accept today, and if we have, then seek to rectify that imbalance."

There is concern over one such clause that unduly penalises trustees if their investment in any way contaminates adversely the fund invested in. Whereas clauses traditionally granted managers indemnity equal to the assets a scheme held in a fund, in some cases they have been ratcheted up in recent years to give indemnity for the whole value of the fund. One potential scenario is that if the scheme's tax exempt status were revoked, it would make the whole fund liable to tax.

First Actuarial founder Hilary Salt warns this would not only wipe out the scheme but also leave the employer having to cover the losses of all the other investors - so in many cases also bankrupting the employer.

While there is only a remote chance of this happening, Salt says it is unreasonable to expect trustees to give managers unlimited indemnity and that sponsors would be "astounded" if they were aware of these clauses.

Managers pushing back
Despite the scrutiny, Salt says it is much easier to negotiate on fees than on clauses like this. "Managers seem much more unwilling to have any kind of discussion over those issues," she says.

A trustee board she works with has recently selected a manager from the investment consultant's shortlist, only for the process to "reached a grinding halt" as the manager's required terms "were just unacceptable".

Managers tend to refuse to make any changes to their standard documentation - especially for smaller schemes - and to say that no other schemes have ever objected, she says.

This puts trustees in a difficult position as they have already spent money on the selection process. They can go to their second choice manager - and risk encountering the same problem - or push ahead on the basis that the costs are too high to justify stopping.

Donnelly argues that managers are almost always able to negotiate on issues and that the old excuse ‘if we do it for you, we have to do it for everyone', is losing ground, however.

She says a lot are willing to adapt, although some are sticking to the old school approach. "With more schemes saying ‘we'll move the money', managers will lose assets if they don't become more adaptable. If a client pushes hard enough and threatens to leave, the manager will try harder to get them to stay."

Donelly says her firm recently succeeded in securing better terms for a small scheme by negotiating well at the early stages. She explains: "We reviewed all the documents and negotiated with the managers before we knew the preferred choice. Two out of three managers were willing to negotiate on this issue, accepted the manager has accountability, and put in place a governance structure that was much more satisfactory."

Take a stand
One way to increase bargaining power is to be very clear about the scheme's boundaries early in the selection process, and ensure the consultant takes it on board.

Also, the more schemes that speak up about their concerns and refuse to follow the status quo, the greater their influence will be.

Salt says trustees should stand up to managers: "If every trustee refused to agree to unlimited liability, investment managers would soon change things."

Managers would be unwise to ignore their clients when there is a constant threat of tougher regulation. As Pickering says: "If managers want contracts to remain free from unhelpful legislative and regulatory intervention, it's in their interests to make sure they don't pull the wool over the eyes of their clients."

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