Is it appropriate to buy FM on fees, or is it a case of "buy cheap and buy twice”
As Paul described in the webinar, there are a number of different types of fee that need to be evaluated as part of a FM offering. It is important to compare ‘like for like’ services, otherwise clients can end up paying for a basic service with lots of expensive add-ons, whereas an alternative manager may have included all of these services initially but looked comparatively more expensive. The starting point is therefore for Trustees to decide what services they require, and get all potential FM providers to quote on that basis.
Is it expensive to move FM providers?
When reviewing a FM provider’s contract it is important to think about exit fees. Are there fees, what are they, how much do they cost, is there a lock in period? If these do exist then it can make moving providers expensive. In addition, Trustees should be sure whether the services they receive can be received without the fiduciary element, i.e. can the client switch investment consultant but maintain the assets on the same platform.
With a bundled fee, expressed as basis points, what is the VAT position? This is entirely dependent on the FM provider and the investment services provided. We recommend it is a question that clients ask their FM provider.
Do performance related fees encourage and reward risk taking over risk management? The potential benefit of a performance-related approach is to directly align the interests of trustees and the FM. However, many believe that a performance fee can create a conflict of interest, such that the FM provider is incentivised to target short-term performance rather than focus on the long-term objectives of the trustees. Performance fees can vary greatly between providers, therefore, it is important to assess whether the performance fee being proposed is suitable for your scheme, and really does align interests with those of the Trustees. Also Trustees should bear in mind with performance fees, what proportion do these fees represent compared to the total annual fee.
Could FMs be reluctant to disclose underlying manager fees as these could encourage trustees to DIY, go direct? All FM providers should provide underlying manager fees when asked by clients; although this may be on an aggregated basis. If they do not, then this is a concern and we would recommend looking at alternative providers. Some Funds will result in discounts when compared to going direct, however, others will not.
Could FM be accused of offering so-called "active" management at a lower cost than the trustees may be able to negotiate themselves, but it's (a) still dearer than passive, and (b) not really aligned with trustees' requirements for investment income and realisable assets with which to pay pensions as they fall due?
FM providers are often better able to negotiate investment manager fees (for both active and passive funds), effectively they receive a bulk discount by pooling together all of the assets under management. Some FMs use a ‘cost pass-through model’ for investment management fees (whereby they do not make any profit on the investment management fees component of the combined fees) and will show the fiduciary management base fees and investment management fees separately in the investment management agreement.
If the Trustees wish to hold a passive portfolio, this should be specified to the FM provider and a comparison of fees incurred from an FM agreement compared to the Trustees investing directly can be achieved, however, FM providers typically use a mix of both active and passive funds, depending on the asset class and the outcomes and objectives set by the client. This is also the case for income and realisable assets. When Trustees are setting the objectives for the FM provider, liquidity issues should be part of the discussion, and options such as regular disinvestments should be discussed.
Do the panel agree that performance reports (which traditionally have been based on time-weighted rates of return) should now be based on money-weighted rates of return. MWRR are also consistent with how actuaries estimate liability costs, are they not?
For unitised funds the manager reports will normally be provided on a Time Weighted Rate of Return basis. However, Trustees will want to look at how their assets have performed relative to the target set for funding their liabilities. Therefore many Investment Consultancies will also provide details of the schemes aggregate asset performance on a Money Weighted Rate of Return (MWRR) basis; as this takes account of the impact of cash flows to or from the scheme’s holdings with each manager. However, comparing individual managers using this MWRR basis can be misleading as the impact of the cash flows will not be equal across managers. It is therefore easier and perhaps better to compare managers using the TWRR approach.
In summary, looking at the scheme return using an MWRR approach is better as this highlights the impact of cash flows. Whereas when you want to compare managers it is important to do this on a like for like basis, so using TWRR is likely to be more helpful; however do not forget the impact of manager fees.
Surely the answer should be "we try to pick best-in-breed, but in practice we will do well to be better-than-average or better-than-peer"?
The question perhaps confuses the reason for selecting a manager and the result. Surely, given a choice you would pick the best-in-breed manager over better-than-average/ better-than-peer manager as you are likely to end up with a better result; even if in some cases this turns out to be only better-than-average/better than peer over your time horizon.
Is it not the case that some investment managers refuse to work with/for FMs?
In our experience, we have found the opposite to be true for many managers. Managers are more than happy to work with us as an FM provider because it provides efficiency savings for both parties, i.e. the investment manager only has to complete one set of due diligence and anti-money laundering documentation to sign up with an FM provider, then it is much quicker and easier for clients to invest with the investment manager.