KAS BANK Guide to Costs

Transcription

1 KAS BANK Guide to Second edition

2 TABLE OF CONTENT Welcome 3 Why are you incurring costs? 4 Where are you incurring costs? 5 Investment Management 6 Case Study: The Superannuation Arrangements of the University of London (SAUL) 10 Starting the cost transparency journey 12 Glossary of 13

3 Welcome to the second edition of the KAS BANK Guide to! Across the pensions and wider investment universe we are increasingly hearing the topic of costs and charges being discussed. Asset owners are seeking greater insights into the costs they are incurring and at the same time, regulators and industry bodies are devoting more time and effort to providing a framework which will capture and disclose these costs. Despite transparency never having been more in demand, the discussion can often feel distant from the day-to-day running of a pension scheme. This guide aims to give a high level introduction to the topic of costs, highlighting some of the key themes and areas that are often misunderstood. What are people talking about? Many of the costs and charges the industry is talking about occur when investing, behind the scenes and are often misunderstood, unknown or unmeasured. This has led to a sense of costs being a mysterious, complex topic. There have also been numerous reports suggesting hidden costs are significantly eroding pension pots and raising the spectre that pensioners face the prospect of having insufficient money for their retirement. Why is it important? Prolonged periods of low returns have resulted in governance bodies closely monitoring savings vehicles to ensure they operate effectively. Identifying a scheme s outgoings to determine if a reasonable price is being paid for the services received is key as governance bodies and trustee boards must demonstrate value for money is being achieved. However, many still struggle to capture this information fully. With understanding of costs remaining limited amongst many market participants, greater educational efforts are needed. In the current environment of volatile markets and low rates, all avenues must be explored to increase schemes funding levels and create better outcomes for members. Put simply, costs can have a significant impact on return. Research shows that the true cost of investment for pension schemes after full cost disclosure is actually between 2-5% per annum. Making small savings quickly can generate enormous gains over a long period for example, a 1% saving over 40 years could lead to an extra 25% of value at retirement 1. What do you need to do about costs? Starting the journey towards transparency of costs can feel daunting, but it is vital to begin that journey. This guide intends to give you a basic understanding of where costs lie in the investment cycle and how they affect your scheme. come in various shapes and sizes, affect different asset types in different ways and can often present themselves differently in DC compared to DB schemes. We will not attempt to address them all in this guide, but we will explain the major cost categories and how they would apply to a traditional DB setup. We hope that by reading this guide you will feel confident that whilst some of these costs may be difficult to obtain, they can be better understood. Clarity and transparency are the best way to improve understanding and if you d like to find out more or discuss your costs in further detail, we d be delighted to help you. Pat Sharman Managing Director, UK KAS BANK 1 Illustrative calculations by the Department for Work and Pensions in November 2013 ( Pensions Bill 2013, Information Pack for Peers ) show that an individual who saves throughout their working life into a scheme with a 0.5% annual charge could lose around 13% of their pension pot at retirement as a result of charges. A 1% annual charge could reduce that pot by 24%. KAS BANK Guide to - second edition 3

4 Why are you incurring costs? are not new you may be familiar with being charged a fee for your bank account or for buying and selling shares. Pension schemes are no different. They often employ external specialists in order to manage and run the scheme successfully and these services all come at a price. Whilst it sometimes feels recently that all costs have been demonised, they are not necessarily a bad thing the key is making sure you have a comprehensive, clear understanding of what your pension scheme is paying and what impact they have on your overall outcome. are incurred step-by-step as you go through the investment and governance process. All investments, regardless of the investor or investment vehicle, follow a broadly similar cycle. Throughout this cycle costs are sustained, some obvious and some less so. It is through understanding the processes and players that comprise this cycle that we can identify how costs are incurred and how we might judge their value. Consider the typical bank account. For looking after your money, reporting your balance to you and facilitating your day-to-day transactions, they levy a charge or they might reduce the rate of return they offer on your account. Consumers may also have an everyday savings account for accumulating funds to, for example, buy a car or send a child to university. Banks know that there will be fewer transactions on these accounts and probably less reporting needed, so they will either lower the fee they charge or perhaps increase the rate of return they are willing to offer. We all know this; we have all spent time searching for the best rates! A pension scheme is simply an extension of your everyday savings account, but has the intention to accumulate funds over a much longer timeframe and earn a sufficient amount for an individual s retirement. The same fundamental investment cycle applies; deposit funds in a secure location, allow them to earn a return and compound over a given time period. Rather than relying on the standard bank interest rate, a pension scheme tries to improve outcomes by investing in various asset types that potentially yield a greater return. This is something that a standard individual is able to do if he/she chooses to do so; however, we have to remember the prerequisites in order to do this effectively. 1) You need basic market knowledge including what asset types are available to you 2) You need up-to-date information about which specific securities are worth investing in 3) You need a comprehensive investment strategy that will enable you to adapt to the long-term investment horizon 4) You need access to the marketplace in order to make the investment 5) You need to store your investments somewhere you can trust and receive reporting on their status As an individual rarely has the capacity to do this on their own, we seek the help of professional institutions who deploy significant resource in specialist areas, benefit from economies of scale, and pass on the benefits to consumers. are inevitable, but it is still essential that the Total Cost of Ownership is understood to enable optimal decision-making and ensure that best possible outcomes are being achieved. Jargon buster Total Cost of Ownership (TCO) The sum of all costs incurred in running a pension scheme or investment vehicle. This should include direct and indirect costs, administrative as well as investment costs, to establish a comprehensive total. The TCO aids purchasing decisions by considering both the purchasing price and ongoing operating charges. 4 KAS BANK Guide to - second edition

5 Where are you incurring costs? Total pension scheme costs (the TCO) can easily be divided into two major categories: Pension Management Investment Management TCO Investment Management Pension Management Pension Management Pension Management are those associated with the running of the legal entity that is the scheme. Ignoring all costs that are associated to management of investments, Pension Management covers purely the administration costs to keep the scheme operational. If the scheme has no investments whatsoever, the scheme would still need to administer pension entitlements, communicate with participants, perform regular audits, and comply with an array of legal requirements. The power of understanding the cost of different options Collecting contributions from members and monitoring when pension payments need to be made is a continuous task, one that could be completed by a direct employee of the scheme, by a member of the scheme s sponsoring employer or outsourced to a specialist provider. Once again, a cost is incurred and there is likely to be several potential options for the way in which the scheme incurs the cost. It is important to understand the cost of all relevant options so that decision-makers can make correct choices regarding the preferred route. This is a consistent approach for the full range of costs incurred. We will not address every cost in this simple guide; however, we think most costs can be grouped into key categories that aid understanding. Pension Management costs can be grouped into the following: 1. Executive costs 2. Administration & Processing costs 3. Advisory & Control costs 4. Rent Executive costs comprise all executive and committee costs incurred as part of the day-to-day management and governance of the scheme. These costs include everything related to executive services, including salaries and expenses, memberships to organisations or publications, as well as any costs associated with conference attendance. Administration & Processing costs involve any costs that are associated with the monitoring or processing of member accounts or communications. This includes internal and external communications, as well as any systems or infrastructure used in order to manage the process. Advisory & Control costs are associated with the support and advisory functions required in the running of the pension scheme (not including those relating to investment activities). These include professional services, such as lawyers, accountants, actuaries and the costs associated with the various regulatory requirements. Rent includes the cost of renting property that is used by the scheme. This could include renting space from the sponsor for the pension scheme. Most Pension Management costs are fairly easily understood, mainly because the costs of running a scheme are no different to the costs that would be needed to run a simple business. Most of the confusion around pension costs is associated with the area of investment management. Typically, this is a very specialist area with several stages in the investment chain, which can often prove tough to break down into the individual cost elements. There are generally several providers contributing specific skill sets along the chain and it can often be difficult for end-users to decipher where costs arise. Once again, it is important to view the costs at a high level and we believe that most costs can be easily segregated into clear bite-sized chunks. KAS BANK Guide to - second edition 5

6 Investment Management Investment Management costs are those associated with any activity relating to the management and monitoring of the scheme s investments. Typically, it is only the percentage management fee paid to an asset manager that is considered in this topic. It is important to remember that there is a large mix of complementary services that take place in the investment chain and all contribute to the total cost of ownership (TCO), that we defined earlier. Investment Management can be can easily be divided into two major categories: Management Fees Transaction Management Fees relate purely to the costs that are incurred from the use of asset managers. You will be familiar with the headline fee, for example 30bps or 50bps.The management fee can be structured and calculated in several ways; however, the most common methodology is to charge a fixed percentage of total assets under management. The percentage charge is determined by a number of different factors, such as the quantity of invested assets, the type of asset you wish to invest in, or the specialism of the manager etc. The headline fee is only a portion of the total charge incurred and it is also important to consider the performance fee which can be thought of as a reward to the manager for delivering positive results. Again, there are several methodologies for how this could be calculated, for example a percentage of any gains, or a fixed figure if the manager surpasses a certain return amount. In either case, it is important to consider both costs and how they relate to the risk / return objectives set out for a given manager. A common example is the 2 and 20 charge structure often used by hedge funds, whereby an investor pays a fixed 2% of the assets invested, and then pays additional 20% of the profits earned on the investment. For example if a 100m investment grows over a year to 120m (after management fees), then the investment might pay 2m in fixed fees (2% of the original AuM) and 4m in performance fees (20% of the = 20m increase). The structures often vary; however, similar models are often found and act as a way of aligning interests and incentivising mangers to obtain investment results. Jargon buster Basis Point Often an investor s assets are so large that measuring a portion of the assets in percent is not productive. A basis point (bp) is 1/100th of a percent. Fees are often measured in bps, meaning a 10 bps charge on 500m of assets would be a cost of 50,000. Jargon buster Management fees vs Performance fees The management fee is often a fixed cost relative to the size of the mandate which is charged irrespective of how the fund performs. You could also pay an additional variable performance fee if the manager has generated investment profits. 6 KAS BANK Guide to - second edition

7 Other Investment Consultancy Custodian Performance Measurement Investment Administration Risk Reporting Investment Management Investment committee expenses TCO Asset Management Fees e.g. Bid-Offer Spreads Transaction e.g. Broker Fees Pension Management Performance e.g. Taxes Executive Administration & Processing Fixed Management Invoiced fees Advisory & Control Research Accounts Rent KAS BANK Guide to - second edition 7

8 Transaction costs If you want to establish the total cost of ownership, then you must look further than the headline charges and understand some of the indirect costs that have an impact. A cost type that can command significant attention is Transaction ; essential costs incurred in the process of buying or selling financial instruments. Although often demonised, transaction costs are a natural charge applied in order to facilitate a transaction, or to compensate a stakeholder in the investment chain. Transaction costs can present themselves in very different ways, whether it is an entry or exit fee for a fund, a brokerage fee to buy a commodity asset, or a financial transaction tax when purchasing a share. Generally, the cost will be a small proportion of the nominal traded amount, a fixed percentage of every trade and although the percentage will remain relatively consistent, the cumulative amount will increase as there is a greater amount of turnover (trading activity). These costs could occur for many reasons that are not necessarily harmful. For example, a trading decision (which incurs a cost) could be taken to benefit an investor by finding a security with a return that will offset the costs. Similarly a cost could be incurred to accommodate an alteration of investment strategy made by an investment committee. Jargon buster Transaction These are many expenses incurred in the process of buying, selling, lending or borrowing financial instruments. Each financial instrument will have some costs that are particular to investing in that area. However, many of these costs apply across all asset classes or financial instruments. Jargon buster Broker A broker is either an individual, or more typically, a company that executes a trade in the market on behalf of an investor. For example, if you or your investment manager makes the decision to buy 1,000 shares in a certain company, the broker goes and finds those shares and purchases them for you. 8 KAS BANK Guide to - second edition

9 Investment Strategy Asset Allocation Investment Governance Asset Management Reporting Safekeeping Diagram: General Investment Cycle Transaction costs are incurred as part of the investment process and will therefore be subtracted prior to the release of the gross return. For this reason, they are often deemed to be hidden; however, that is not necessarily the case. Transaction costs have generally been undisclosed in order to simplify the process for consumers and you will find that most asset managers are happy to provide this information if requested. When discussing costs, most focus their investigation solely on asset management fees; however, it is important to remember that there are several other components and stakeholders that make up a general investment cycle. Jargon buster Custodian Before you even allocate an asset manager, the various pension scheme committees will decide upon agreed investment strategy, which will correspond to a strategy including an asset allocation. This would generally be aided by the professional expertise of an investment consultant. They might also perform a continual monitoring of the strategy to ensure it is fit-for-purpose, adjusting it over time. You will also require a custodian to safe keep all of the assets in your portfolio, and require the expertise of an investment administrator to report on the current value of assets. You might also be interested in receiving reporting about the various risks that your scheme is exposed to, or the recent performance of the portfolio. All of these tasks are performed by specialist service providers and once again command a fee for their expertise. All these providers enable better governance of your investments and provide valuable information to trustees and governance committees. Custodians hold securities (e.g. stocks & shares) in safekeeping for investors to ensure they are not lost or stolen. They often perform related tasks - Securities Services such as collecting dividends and interest payments on clients investments. KAS BANK Guide to - second edition 9

10 Case Study: The Superannuation Arrangements of the University of London (SAUL) SAUL was set up in 1976 to provide pensions for non-academic staff of the University of London. SAUL currently has a total of 3.2 billion AUM. The Scheme provides pensions to over 50 organisations with links to Higher Education and has over 50,000 members. Background While SAUL s Investment Committee has long been aware of the types of investment costs incurred and approximate values, obtaining full detail from all managers on a consistent basis and in a timely manner has been challenging. SAUL was eager to undertake a comprehensive overview of its costs, which ultimately will enable it to check it gets value for money. SAUL s key objectives were to: Improve transparency of cost reporting for the Scheme Prepare for upcoming regulatory scrutiny of cost disclosure Acquire tools relating to cost analysis to help improve decision-making Process Using two standardised data collection templates, KAS BANK engaged with the Scheme and all of its managers and advisers, requesting clearly defined data in a consistent manner. Upon receipt of this data, KAS BANK performed a series of validation checks to ensure all data points were aligned with expectations and within an agreed tolerance. Maintaining this granular level of data allows KAS BANK to aggregate or disaggregate information upon request which gives the user maximum flexibility when creating custom analysis. KAS BANK organises and delivers this data digitally via a clear and intuitive App, which the user can navigate and investigate areas which are of interest to them. There are multiple displays and functionalities, offering a range of options for bespoke reporting. Outcomes The initial Cost Transparency & Benchmarking exercise with KAS BANK provided SAUL with an improved visibility of its costs than those disclosed in its annual reports/accounts using industry standard accounting practices. The Scheme can now benchmark the costs of its asset managers, comparing mandates within the Scheme to the cost of others externally. The exercise has allowed SAUL to: Capture & analyse the costs which are typically unreported on a consistent basis Demonstrate accountability and good governance Benchmark the costs to ensure they are appropriate given the investment strategy and beliefs 10 KAS BANK Guide to - second edition

11 Kevin Wade, Chief Investment Officer for SAUL commented, SAUL is very pleased to be working with KAS BANK on this cost transparency project with data aggregated to provide anonymity. Its detailed and diligent approach, along with its analysis of SAUL s investment managers responses on the costs, will prove invaluable. Their Cost Transparency & Benchmarking Service offered a comprehensive view of costs at a good value for money relative to the probable cost of conducting the investigation internally. The initial exercise is only the beginning of SAUL s cost transparency activities; they have opportunities for further analysis and are keen to investigate underlying pooled fund data (including custody & administration fees), transaction costs in alternative asset types, value for money from performance fees and to monitor trends over multi-periods. This activity is now established as a critical part of the Scheme s governance and will be monitored on a regular basis going forward, forming an essential part of the Scheme s decision making. SAUL is very pleased to be working with KAS BANK on this cost transparency project with data aggregated to provide anonymity Kevin Wade, Chief Investment Officer for SAUL October 2017 KAS BANK Guide to - second edition 11

12 Starting the cost transparency journey Understanding your scheme s costs is likely to be a journey that takes some time but it is essential to start as soon as possible. Cost comprehension is a must-have in this day and age, especially as improved control of your costs will likely have a beneficial effect to the sponsor and end member. Small savings now can amount to significant gains over the long-term delivering better outcomes for members. This Guide has hopefully provided you with some insights which will allow you to begin your own cost transparency journey and investigate your own scheme s costs in more detail. With understanding comes the ability to command standardised and consistent disclosure, which in turn enables more effective comparison and better decision making. So how do you begin? Practical steps you can take include: Start investigating costs with the information that you have ready access to Discuss with your managers and consultants whether they can explain the undisclosed costs of your scheme Communicate your efforts and findings to your members and peers If you need support, seek assistance from specialists in cost transparency who can assist you in delving deeper into the subject Being able to identify and quantify these costs provides a more comprehensive picture of what you are paying and can lead to you being more in control of your scheme, and therefore able to make the best informed decisions possible. Effectively, it is part of enhancing and demonstrating good governance of your scheme. 12 KAS BANK Guide to - second edition

13 Glossary of We have provided a list of the most common cost terms that you might encounter in your cost transparency journey. This is, of course not an exhaustive list but we hope it will help you with initial discussions. Advisory and control costs The costs associated with the support and advisory functions required in the running of the pension scheme. Including all fees paid to external parties (not including those relating to investment activities). Administration & Processing cost The costs involve any costs that are associated with the monitoring or processing of member accounts or communications. This includes internal and external communications, as well as any systems or infrastructure used in order to manage the process. Appraisal Fees The cost of paying a qualified appraiser to estimate the market value of a property or investment. Auditing Fees charged to a fund for the audit of their financial records and preparation of any tax documents. Basis Points Often an investor s assets are so large that measuring a portion of the assets in percent is not productive. A basis point is 1/100th of a percent. When fees are measured in basis points this would mean that 10 basis point charge on 500m of assets would be a cost of 50,000. Broken Deal Expenses The costs received from and paid to counterparties upon termination when a fund s acquisition is unsuccessful. Custodian fees The amount you pay for your custodian to fulfil their safekeeping role. The other Securities Services that your Custodian provides to your scheme might be incorporated into a bundled price. Therefore, it is worth separating out the costs of safekeeping from those of services such as fund accounting, treasury services and tax reclaim. Estate Agent Fees If an investment is made directly into property holdings there is likely to be estate agent fees incurred. Execution Commission The commission paid for the execution of an equity, fixed income or commodity transaction. For example, the commission paid to a broker for executing and equity trade. Executive All executive and committee costs incurred as part of the day-to-day management and governance of the scheme. These costs include everything related to executive services, including salaries and expenses, memberships to organisations or publications, as well as any costs associated with conference attendance. Fiduciary Management Some schemes chose to outsource the investment process to a Fiduciary Manager. The manager potentially takes over a number of activities, each of which has an individual cost that is passed on to the scheme. These activities include: Proposals for strategic investment policy, including ALM studies Advice on risk management and balance sheet management Proposals for portfolio composition and implementation Performance Measurement Communication and reporting to the trustee board Selection and monitoring of external managers Outsourced custody and securities services KAS BANK Guide to - second edition 13

14 Fiscal & Legal Consultancy Fees A fund might require legal services, for example if it wants to amend its set-up. These costs may be indirectly passed on to the client. For Research Commission Commission paid in return for research, analytics, trading technology etc. that is used by the investment manager for the mandate. For example, the execution fee on an investment may be 1 but the manager might pay an extra 1 to cover the cost of research provided alongside execution. Investment Advisory The amount you pay your investment consultant for all services they provide. This not only includes consulting but also functions such as manager research, which you may have a separate fee structure for. Investment Management The costs associated with any activity relating to the management and monitoring of the scheme s investments. This is the total for all investment practice, including all asset manager costs, investment service providers, investment advice, etc. Investment Manager Manager The amount your scheme is invoiced by your asset managers for management fees, such as the Annual Management Charge. This is typically a contractually agreed amount expressed in basis points of the size of the mandate. Investment Manager - Performance The amount you are invoiced by your scheme s asset managers for their performance. This sits on top of the AMC and is the amount you pay the fund manager for positive results. This is usually relative to the fund s profits. Performance fees An additional variable performance fee when the asset manager has generated positive returns. Placement Fees The fees charged when client funds are placed into property, infrastructure, hedge or private equity funds. This is usually done by a bank or broker who will charge for this service. Registration Fee Any costs or charges that occur when registering a new security or investment. Rent The cost of renting property that is used by the scheme. This could include renting space from the sponsor for the pension scheme. Stamp Duty/ Financial Transaction Tax Governments often change taxes or fees on certain investments or transactions. For example, the UK government levies stamp duty on all UK equity purchases. Total Cost of Ownership (TCO) The sum total of all the costs you incur in running a pension fund or investment vehicle. This should include direct and indirect costs, administrative as well as investment costs, to establish a proper total. Transaction These are any expenses incurred in the process of buying, selling, lending or borrowing financial instruments. Each financial instrument will have some costs that are particular to investing in that area. However, many of these costs apply across all asset classes or financial instruments. Pension Management The expenses involved with managing and administering the pension fund itself. They are incurred as part of the day-to-day running of the scheme and are not related to investment activity. 14 KAS BANK Guide to - second edition

15 Disclaimer: Although the information in this brochure has been put together with the utmost care and, in KAS BANK s opinion, accurately presents the state of affairs at the time of publication, KAS BANK cannot guarantee that this information is and/or will remain accurate and complete. KAS BANK therefore accepts no liability for damage or loss resulting from the use of, reliance on or actions or omissions in response to the information in this brochure. KAS BANK Guide to - second edition 15

16 KAS BANK Amsterdam P.O. Box DB Amsterdam The Netherlands De Entree EE Amsterdam The Netherlands KAS BANK UK Branch 11 Westferry Circus London, E14 4HD United Kingdom KAS BANK German Branch Frankfurt Mainzer Landstraße Frankfurt am Main Germany