As the CMA’s remedies for the fiduciary management market bed in, schemes should be thinking more about how fees are structured, says David Hickey
We've been having an increasing number of conversations with pension trustees about the structure of fees for fiduciary management in recent weeks. That reflects both the report from the Competition and Markets Authority (CMA) published at the start of the summer and the EY fees survey. There is both a push and a pull for greater transparency and, just as importantly, the total costs of investing.
The past: Fixed, cost-plus and performance-linked
Since fiduciary management is still relatively young in the UK (around 10 years old), it is worth reviewing the development of fees to date. Many trustees will have seen the industry arrive as an overseas innovation and develop into its current incarnation. The mature Dutch market has been anchored around a cost-plus fee as a percentage of assets for some time. However, the initial set-up in the UK has been a bit of a mixed bag.
- Fixed: Many early (small scheme) adopters used an all-inclusive fixed percentage (or rather basis point) of value, as the first step away from adviser fees. This was simple and created cost certainty, but it often didn't provide transparency as to how much went to the fiduciary manager, and it also presented conflicts for the fiduciary manager in picking underlying managers with higher or lower fees with a loss or profit then hitting the manager.
- Cost-plus: The UK then embraced the cost-plus arrangement, where fiduciary management, asset management and other administration costs are separated (reducing conflicts and adding transparency). However, transparency of reporting initially varied around fund charges and internal asset management charges.
- Performance-linked: This was then followed by the offering of performance-linked fiduciary management fees, linked to either asset or funding level outperformance. Anywhere from 10%-50% of the fee may be linked. This happened as the market became more competitive, but such fees can create misaligned incentives and require the manager to have a relatively highly delegated mandate.
Past or present? Expensive versus traditional advisory?
There is a perception that fiduciary management is expensive and there has been an association with an increase in overall fees. We think this varies between providers and in general, as measured by the EY survey, there has been a decline in costs since 2013.
Initially, it is likely that the expansion of services compared to a traditional adviser model may have been associated with a rise in fees. However, this may have simply been a reflection of which provider was selected. A possible explanation may be mandates going to newly established firms (around 10 years ago) that typically have higher initial operational set-up costs compared to asset management firms with long-established operational platforms.
Layering of fees is sometimes evident in ‘manager of managers' structures. However, economies of scale should offset this, dependent on the negotiating power of the manager. A fixed, all-inclusive, fiduciary management fee rate may have also obscured the general fall in asset management fees and moves towards increased passive/systematic allocations. Certainly, the thrust of the CMA's report is to ensure greater transparency on costs and to require competitive tendering for those who have not been exposed to the marketplace, as well as general fee compression of charges. Whatever the fee structure, underlying costs must be transparent and regularly reviewed.
Most clients using fiduciary management (particularly the most recent mandates) have a cost-plus structure. This splits out fiduciary management, asset management and other administration costs. Some obvious advantages are that cost savings in other areas are fed directly back to the fund; the fee is aligned with the value of the fund; and there are no punitive penalties, like the higher cost of a strong-performing asset manager effectively coming out of the fiduciary manager's fee.
Many fiduciary managers still offer performance-linked fees, however, their adoption has been limited. A key issue has been the problems with directly aligning fees with the trustees' target of improving funding. That requires not only ceding control over asset allocations, but also liability hedging. This has left performance-linked fees in the minority. However, as with fiduciary management itself, it is never an all-or-nothing discussion and there are a range of ways to link fees to the performance of sub-sets of managed assets.
While the CMA is also pushing for benchmarks to encourage performance comparison, its push for fee transparency, rather than commoditisation, is the way to improve the marketplace. It is no simple task to compare the performance across approximately 1,000 mandates and multiple providers when delegation and asset class permissions vary, but transparency should be a given and will open some eyes.
- We expect all fee types to remain, but clear breakdowns provided in all cases. This should lead to the cementing of cost-plus as the preferred model since it is simple and transparent.
- Transaction costs will now also be specified: systematic strategies with high transaction costs may surprise some trustees who see this as a low-cost option. There may even be a small tilt back to fundamental investing.
- The costs of switching provider will emerge (as re-tenders are forced on two-thirds of the market), a relatively rare occurrence up to now given the uncompetitive and closed nature of appointments. We expect the costs of switching to be relatively low.
Factors to lower fees
There are plenty of opportunities for fiduciary managers to deliver economies of scale to offset the cost of providing delegated services.
- Consolidation of assets is typically cited as one of the key benefits of fiduciary management where one party can negotiate on behalf of all clients in a consolidated manner with greater economies of scale. This does vary between managers depending on their operating model.
- Enhanced quantitative methods in screening managers and improved automation of funding level monitoring and reporting are areas that may be streamlined.
- We may even see schemes pre-agree lower fees should de-risking occur (as part of a journey plan). This is something we already do.
- We expect CMA-enforced tendering to see a general fall in fees as schemes pay closer attention to the effectiveness of asset manager platforms vs consultants.
- We also expect further increased scale as fiduciary management emerges as the preferred governance model. It is expected to represent around 30% of defined benefit pension assets in the long term. This may also expedite the move towards lower fees.
Factors to support fees
- Providers may oversell the ‘illiquidity premium' story. This would funnel capital into alternatives and private markets - assets with relatively short track records, thus reducing trustees' optionality but increasing fees.
- The increased focus on ESG may bring with it higher servicing fees.
- Popularity of buy-in and buyout strategies, as well as price-tracking services, will grow as schemes evolve.
We see scope for a further reduction in the average level of fees, but particularly overall costs, as extras are no longer hidden. Transparency in transaction costs, annual management charges, and fund costs will help.
We see competitive tendering as leading to greater questioning of fees and additional costs, including the cost of switching provider.
However, hauling funding levels up is a difficult and complex task. There are a lot of services and duties to undertake to manage asset and liability risks well, so we shouldn't see a race to the bottom in fees.
We expect trustees to ask their providers to tier their fees and agree a lower price for a de-risked strategy. At the same time, one should not forget there's a great deal of work a fiduciary manager can do in running an end-game portfolio (it's never set and forget) and/or facilitating a buy-in/buyout. Different strategies should warrant different fee structures.
David Hickey is a managing director and head of UK fiduciary solutions at BMO Global Asset Management
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