Many schemes are still not engaging on costs

In defined benefit pension plans, every pound taken in cost needs to be recouped through improved performance or put back by members, employers or, in the case of public schemes, taxpayers.

In defined contribution plans, costs reduce the value of the member’s account with long-term retirement implications for the member. In small pots they can have a material impact on the value left behind.

The industry will soon have the data necessary to measure investment manager performance at a more detailed level and make better decisions as a result

Proprietary CEM research shows that, in the long term, more than two-thirds of the value created by active investment management is consumed by cost. At the same time, paying more doesn’t always get you more – there is no correlation between what schemes pay and the added value they achieve.

You wouldn’t buy a pair of shoes if you didn’t know the cost but, until now, most pension fund trustees have little or no idea of the cost of running their schemes – and those that do often have no idea if they are reasonable.

So costs really matter, and the work that is being done on transparency is both welcome and helpful.

Schemes still deciding cost approach

The new cost disclosure regime in the UK is really in its infancy and there is much work to be done. From April 2018, new Department for Work and Pensions regulations came into effect around the disclosure and publication of the level of charges and transaction costs within DC schemes. Right now, schemes are busy working out how to collect and disclose that cost data.

In the DB world, many private sector schemes have yet to tackle the cost issue. In our experience, it is only the largest private sector DB schemes and local government pension schemes that are really focusing on cost – so the Financial Conduct Authority’s cost disclosure templates will make it easier for everyone.

However, even if a scheme does have the data, it’s important that cost doesn’t unnecessarily consume the trustee agenda.

Trustees should gain an understanding of total costs, ensure those costs are disclosed as required and that they are reasonable given the parameters of the scheme and performance.

This almost certainly necessitates a comparison with other schemes on a sensible, like-for-like basis, which probably only needs to happen once a year and should be a means for trustees to hold management and advisers to account.

Managers should face tougher questions

Trustees should not get bogged down in detail, but fund executives and professional advisers should. Their job is to implement the trustees’ strategy and a vital part of this is the appointment and oversight of providers.

As this is where quality data is critically important, schemes should be asking more probing questions of their investment managers.

We expect the impact on the investment industry, when it comes, will be at the margin, as the majority of asset managers will be acting within parameters that are understood by and acceptable to the pension schemes they serve.

A few managers will not be so aligned. Most likely it will be that the remit is not properly understood or is unclear and managers may be trading unanticipated volumes and/or incurring high transaction costs. What are pension schemes likely to do with that information?

Consider cost in context

First, they may discover that they have little influence over the manager’s approach, particularly within pooled funds.

If the manager is performing well in every other respect, then schemes may be reluctant to change. More likely, it will be a final nail in the coffin of an already underperforming manager and, at the extreme, there may be examples of where managers may be working unethically and need to be held to account.

At the end of the day, what gets measured gets managed. The industry will soon have the data necessary to measure investment manager performance at a more detailed level and make better decisions as a result. Until then, trustees should ensure they are asking the right questions.

John Simmonds is principal at CEM Benchmarking