Trustees lack understanding of implicit costs
- Trustees have a better grasp of costs than some realise
- They have a wide understanding of explicit costs
- But they are less familiar with implicit costs such as securities lending
Research suggests trustees have a good understanding of basic charges but are less certain on other costs. Michael Klimes looks at the findings
There is a narrative in some quarters of the industry that trustees do not know enough about costs and fees when it comes to fund management. However research conducted by Aon Hewitt in partnership with the Leeds University Business School challenges this belief.
A paper called Cost, Fees, and Trustee Decision-making looks at how well trustees grasp costs and fees in fund management.
The research looked at 197 mainly defined benefit (DB) trustees and scheme managers (11 were DC trustees) running schemes of various sizes. Schemes ranged from less than £15m of assets under management (AuM), up to those with more than £5bn AuM, with 60% ranging between £100m and £2.5bn.
The findings
According to the paper, trustees rank investment strategy and asset allocation ahead of costs and fees when considering pension fund outcomes. Up to 84% of respondents understand explicit fees, such as basic net of fees calculation when evaluating a fund. They can even understand the basic net of fees calculation when distracted by other information.
Leeds University Business School associate professor Dr Iain Clacher (pictured above) who led the research, points out it undercuts the stereotype of trustees. "There is a narrative that fund managers put the wool over the eyes of trustees. But broadly speaking, our research shows trustees are picking the best funds on a net fees basis. Some may think they are not doing this but they are."
Furthermore and most importantly for Clacher, trustees are able to focus on the big picture when it comes to investment decisions. "Value for money is an ethereal concept. If trustees just focus on costs they are not going to understand value. That requires strategy and the most interesting thing is that fees and costs are not as important to trustees as strategy in the survey."
Explicit costs
While the findings put trustees in a good light, there are some areas where they score less highly, particularly their understanding of implicit costs. Respondents were asked about their familiarity with fund management terms such as market impact costs, securities lending and single swinging price.
Trustees understood these terms the least (see chart below). The level of familiarity decreases across nearly all costs for trustees in small schemes, both implicit and explicit.
Explaining the difference in performance between small and large schemes, Aon Hewitt senior partner John Belgrove says: "You can discern from the research that as you move from large schemes to small schemes, the governance standards decrease for some. Trustees in small schemes might be less likely to challenge the consultant viewpoint and there is work to be done here."
When it comes to all trustees, Clacher argues the lower level of understanding of explicit costs grows in relation to the interim report of the Financial Conduct Authority's (FCA) Asset Management Market Study. "If the market is heading in the direction of more disclosure and transparency then there will be more esoteric concepts and terms."
In its interim report published last November, one of the FCA's recommendations is that there should be one "all-in-fee" that gives investors a full view of what they pay.
Work has also been done by the Transparency Task Force which created a template listing more than 300 types of cost or charge on investments which can affect schemes.
If the FCA and transparency activists get their way, then there will be consequences for how trustees fulfil their fiduciary duty to members.
"Trustees will need to have greater understanding of implicit costs. Otherwise increased disclosure, transparency and just more information will not help trustees make solid investment decisions," Clacher continues.
He warns there could be unintended consequences if trustees are swamped by too much information. "Fund management fees and costs are often judged as opaque and complex, but a full disclosure of implicit costs and fees may result in information overload and prevent effective decision-making. Similarly, there may be a fixation on costs over value and it is the combination of both that is crucial to effective investment in pension funds."
While the debate on transparency around fund management continues, maybe DB trustees can take some encouragement from the findings which show they demonstrate a solid understanding of explicit costs and fees. However, if the standards for disclosure go up, the demands on trustees will become even greater.
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