Cost disclosure is only valuable if you know how to use it

With this in mind, the introduction of the Financial Conduct Authority’s new template for the disclosure of cost and performance data is both important and welcome, as it will provide a whole new level of information to pension schemes when introduced.

It will be easy for boards to be overwhelmed by the new data, so a means to make sense of the template data will be critical

Schemes will want to decide whether the data is valuable to them and, if so, what they should do with it. Many trustee boards will want to have a firm handle on costs, but they do need to understand the following:

• Are our costs reasonable?

• Are we getting value for money?

• Are my executives and/or advisers addressing any issues of poor value?

So how and when the data gets refined for the board is essential. An annual summary at board level is likely to be more than sufficient as, although costs are important, they should not dominate the board’s whole agenda.

How to make data useful

A framework for comparison is also needed, to distil data to a headline level and then compare with other similar pension funds. Establishing the right peer group for comparison is important.

The framework needs to adjust for asset mix and size because both significantly affect cost – and it also needs to explain why costs are high or low and to highlight outliers.

This explanation is critical for schemes to be able to understand their costs, and for focusing attention on areas within the portfolio where fees are unnecessarily high. It will be difficult for schemes to do this work themselves, so they will need external help.

How funds implement their strategy is often a bigger driver of total cost differentials than manager fees.

Large funds are increasingly bypassing the commercial fund management industry and building teams to invest directly, while small funds sometimes have to use expensive structures to access some asset classes.

Transaction costs are a key component

But a wide range of cost factors are entirely within schemes’ control. These include whether to use active or passive management, internal, external or fund-of-funds, and ought to be accounted for in determining whether costs are reasonable.  

Transaction costs among a peer group of some of the world’s largest funds in 2016 were about 21 basis points, according to our research.

Total costs for the same funds, including transaction costs, internal costs, performance fees and carried interest were close to 82 bp – so transaction costs were broadly 25 per cent of the total.

These averages disguise the spread, however, as there were wide variations at both a fund and asset class level; 20 bp should be taken as an indicator that transaction costs are material rather than a rule of thumb for the total amount of transaction costs.

Do not stop at public markets

It is also worth noting that more than 50 per cent of the cost of operating a defined benefit pension scheme can be incurred by just 5-10 per cent of assets. Fees paid on private equity and hedge funds in particular are the really important total cost drivers.  

The FCA should move quickly beyond public markets and produce a workable template for private markets. They would do well to work alongside the Institutional Limited Partners Association, whose template for general partners to share costs consistently has enabled funds to better understand their private market costs.

Ideally we need one global standard template. The ILPA template is not perfect, but it is a good baseline and can be improved.

Ultimately, being high or low cost is neither good nor bad – the value-for-money question is paramount.

Boards should be assessing performance, risk, cost and implementation strategy together. It will be easy for boards to be overwhelmed by the new data, so a means to make sense of the template data will be critical, as will a clear focus on what is important.

John Simmonds is a principal at cost analysis service CEM Benchmarking