Past, present and future of fiduciary management fees

Our views on the direction of future change.

Risk Disclaimer

Past performance should not be seen as an indication of future performance. The value of investments and the income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

We’ve been having an increasing number of conversations with pension trustees about the structure of fees for fiduciary management (FM) in recent weeks. That reflects both the report from the Competition and Markets Authority (CMA) published at the start of the summer and the FM fee survey from EY. There is both a push and a pull for greater transparency on fiduciary fees and, just as importantly, the total costs of investing. We therefore wanted to put together our observations on the current state of play and share our views on the direction of future change.

Risk Disclaimer

Past performance should not be seen as an indication of future performance. The value of investments and the income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

The past: UK FM fee history: fixed, cost-plus and performance-linked

 
Since FM is still relatively young in the UK (around 10yrs old), it is worth taking a moment to review the development of fees in the industry to date. Many trustees will have seen the industry arrive as an overseas innovation and develop into its current incarnation. The mature Dutch FM 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 FM in picking underlying managers with higher or lower fees with a loss or profit then hitting the FM.
  • Cost-plus: The UK then embraced the cost-plus arrangement, where FM, 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 performancelinked FM fees, linked to either asset or funding level outperformance. Anywhere from 10-50% of the FM fee may be linked. This happened as the market became more competitive, but such fees can create misaligned incentives and require the FM to have a relatively highly delegated mandate.

 
Let’s now review the current discussions that we are having with trustees about how these developments have worked in practice.

Related capability

Fiduciary

Past or present? Is FM expensive vs traditional advisory

 

There is a perception among trustees that FM 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 offered by FM 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 of this 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 are sometimes evident in ‘manager of managers’ structures. However, economies of scale should offset this, dependent on the negotiating power of the fiduciary manager. A fixed, all-inclusive, FM 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 report from the CMA is to ensure greater transparency on costs and to require competitive tendering for those who have not been exposed to the marketplace (asset manager pricing vs consultants) as well as general fee compression of FM and asset manager charges. Whatever the fee structure (fixed, cost-plus, performance-linked), underlying costs must be transparent and regularly reviewed.

The present

 

Most clients using FM (particularly the most recent mandates) have a cost-plus structure. This splits out FM, asset management and other administration costs. Some obvious advantages are that cost savings in other areas are fed directly back to the fund; the FM 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 the fiduciary managers’ fees with the trustees’ target of improving the funding level. That requires the trustees to not only cede control over the asset management allocations, but also the liability hedging. This has left performance-linked fees in the minority. However, as with FM 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. Every pension fund and strategy is unique and the priorities of different trustee boards is crucial.

The future

 

Transparency

While the CMA is also pushing for benchmarks to encourage performance comparison across the industry, we see their push for fee transparency, rather than commoditisation, as the way to improve the marketplace. It is no simple task to compare the performance across approximately 1,000 FM mandates and multiple providers when delegation and asset class permissions vary by mandate, but transparency should be a given and will open some eyes.

  • We expect all fee types to remain in the industry, but clear fee breakdowns to be 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 from one provider to another will emerge (as re-tenders are now forced on two-thirds of the FM 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 FM 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 we see that may be streamlined.
  • We may even see schemes pre-agree lower FM fees should a de-risk occur (as part of a journey plan). This is something we already do for clients.
  • 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 FM emerges as the preferred governance model for DB pension schemes. FM is expected to represent around 30%1 of DB pension assets in the long term. This may also expedite the move towards lower fees.

 

Factors to support fees

  • There is the possibility that 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 (asset manager and FM).
  • The increased focus on ESG may bring with it higher servicing fees.
  • Popularity of buy-in and buy-out strategies as well as price tracking services will grow as schemes evolve.
Overall conclusions

So, where have our discussions with trustees led us? We see scope for a further reduction in the average level of FM 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 FM fees and additional costs, including the cost of switching from one provider to another.

However, hauling a pension scheme’s funding level up is a difficult and complex task, there are a lot of services and duties to undertake to manage multi asset and liability risks well, so we shouldn’t see a race to the bottom in FM fees.

We expect trustees to ask their FM 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/buy-out. Different strategies should warrant different fee structures.

BMO Fiduciary Solutions

BMO Global Asset Management manage more than £20bn of fiduciary assets globally and have over 150 clients in the UK, Netherlands and US (as at 30 June 2019). We have run FM mandates for over 30 years and focus on tailored solutions for each client. Globally we manage more than £215bn of assets (as at 31 July 2019) combining our core capabilities in LDI/CDI, manager research, multi asset and responsible investment to build open architecture, cost effective portfolios.

 
1 BroadridgeUK DB Navigator 2018.

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