Shropshire County Pension Fund will become the latest local authority scheme to increase its passively managed equity allocation in order to reduce its investment management fees.
Passive management can create substantial savings on schemes’ management charges and free up governance resources for other decisions, but consultants have warned they could risk losing out on performance.
Passive managers are a lot cheaper, that was one of the main drivers behind it
The £1.2bn fund will increase its passively managed equity allocation to 20 percent in global equities for 2013/14 from the current 9 per cent in European equities, after reviewing the structure of its fund, according to its2013 annual report. The scheme will also hire a new manager.
Justin Bridges, the council’s treasury and pensions service manager, said the fund took the decision to reduce investment management fees and risk.
“Passive managers are a lot cheaper, that was one of the main drivers behind it,” said Bridges. “Some of our active managers weren’t performing particularly well,” he added.
The scheme’s total management fees for 2012/13 were £8.2m, compared with £5.7m the previous year, according to the report.
Last yearBarking and Dagenham Council Pension Fund reallocated 25 per cent of its equity holdings from active to passive management.
David Dickinson, pensions and treasury fund manager, said the switch had generally reduced investment management fees by around 40 basis points.
“Just before we did it, we did not think the savings were going to be as much as that,” said Dickinson.
Active management can add value, provided schemes have the time and resources to oversee active managers, said Tim Giles, partner at Aon Hewitt.
But schemes must have conviction that they have chosen the right managers, and not spread them too thinly as this risks diluting returns.
“Some mandates aren’t broad enough, if you actually believe in active management you want to be making sure you are giving managers enough latitude to add value,” Giles added.
Benefits of passive management
The primary benefit of moving from active to passive management is value, which has strengthened in recent years.
“The fees for passive management have come down quite a lot over the past few years and they’re significantly lower than the active management costs,” said to David O’Hara, principal investment consultant at KPMG.
Linda Selman, partner at Hymans Robertson, said the pressure to reduce costs is one of the main reasons for local government pension schemes making the switch to passive management.
Passive investing also frees up more governance time, allowing schemes to concentrate on making sure their asset allocation is correct, which more important in driving the fund, according to O’ Hara.
“There’s also evidence that hiring and firing of [active] managers has not necessarily been done at the right time, therefore destroying value,” said Selman.
Local government pension schemes have been diversifying the type of passive management they employ.
Traditionally, passive managers have invested in line with market capitalisation indices, however there are new approaches such as fundamental indexation.
“Rather than looking at companies’ market capitalisation you look at underlying drivers of the company such as earnings, profit or cash flow, and use that as a basis for passive investment," said O’Hara.
