Fiduciary Man nagement Insights Fees Survey March 2014
Contents Executive summary 1 Introduction 4 Components of fees in a fiduciary management mandate 5 Context for survey 6 Base fiduciary 7 Investment 10 Base fiduciary plus investment 12 Other fees 13 Getting help 14 Appendix: how to read a box plot 15
Executive summary Fiduciary management is a service, not a product. As pension scheme trustees often require different services from their fiduciary managers (FMs) it is difficult to make apples-to-apples comparisons of fees. That being said, in this survey, we have tried to do just that we have compared the relative fees of FMs providing a specific array of services and managing to a specific investment policy for three hypothetical pension schemes with 50m, 250m and 750m in assets. The results of this survey are based on responses from 11 FMs who, collectively, manage the significant majority of assets in the UK fiduciary management market. The highlights of our findings are as follows: Base fiduciary The base fiduciary cover the vast majority of services the FM provides including advice, modelling and implementation. The base fiduciary for the participating FMs were distributed as follows: Figure i distribution of base fiduciary (bps) 0.40% 0.35% Median 0.35% Q3 0.36% 0.30% 0.25% 0.20% 0.15% Q1 0.28% Median 0.25% Q3 0.26% Q1 0.15% Median 0.16% Q3 0.20% Q1 0.15% 0.10% 0.05% Small 50m Medium 250m Large 750m As you can see, except for a small number of FMs offering lower fees for small to medium sized schemes, base fiduciary are reasonably clustered demonstrating the competitiveness of the fiduciary management market. Of note, base fiduciary, measured in basis point terms, decrease as the asset base increases. This reflects that fiduciary management is a service and that certain services are required regardless of the size of the pension scheme. The vast majority (80%) of FMs are willing to incorporate a performance-related component into their base fiduciary whereby the base fiduciary could increase if the FM attains certain pre-agreed performance metrics. However, within this group of FMs, most had a relatively small proportion of their existing client base that had elected to use this approach. 1
Executive summary (cont d) Combined base fiduciary plus investment In a fiduciary management mandate, in addition to the base fiduciary the trustees will also need to pay the investment for the underlying investment fund managers selected by the FM (in some cases the FM is the underlying investment manager). Indeed, one can view the required ongoing cost of a fiduciary management mandate as the base fiduciary plus the underlying investment. In our survey these combined fees were as follows: Figure ii combined base fiduciary plus investment (bps) 0.90% 0.85% 0.80% 0.75% 0.70% 0.65% 0.60% 0.55% 0.50% 0.45% 0.40% Q3 0.77% Median 0.71% Q3 0.69% Q1 0.69% Median 0.63% Median 0.57% Q1 0.56% Small 50m Medium 250m Large 750m Q3 0.67% Q1 0.50% Interestingly, for our three hypothetical pension schemes, the FMs with the lowest base fiduciary had higher investment for the model portfolios that we specified and vice versa we see a more even distribution of results with dispersion increasing as asset size increases. As the fiduciary management market grows, we expect that competitive pressures will put downward pressure on overall fiduciary. Using these survey results The survey results within this document represent a like-for-like comparison for a specific set of services for three hypothetical pension schemes. We encourage trustees and sponsors who have existing fiduciary manager appointments not to draw direct comparisons to their own pension schemes as the comparison may not be like-for-like. For the same reasons, we would caution parties interested in moving to a fiduciary management approach against using these figures as benchmarks for their expected fees. 2
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Introduction One of the questions we are frequently asked by parties interested in fiduciary management is how much will it cost. The answer to this question is not necessarily straightforward. Fiduciary management is a service as opposed to a product and, as with most service provision, the cost will depend on exactly what services are provided. In our experience, whilst the fiduciary management mandates we have seen have many traits in common, there are often significant differences from scheme to scheme and these differences typically have cost implications. That being said, the cost question is entirely sensible and one we feel deserves investigation. Accordingly, to give interested parties a greater understanding of what the cost of fiduciary management could be, EY have conducted this fiduciary survey. The information in this survey is based on responses received in the third quarter of 2013 from 11 fiduciary managers who serve the UK fiduciary management market (listed below). Collectively, these 11 firms manage the significant majority of assets in the UK fiduciary management market. We would like to extend our gratitude to these firms for participating in this survey. Alliance Bernstein BlackRock MN SEI Allianz Global Investors Goldman Sachs Asset Management P-Solve Towers Watson Aon Hewitt Mercer Russell Investments We hope that you find this survey useful. Iain Brown Partner and Head of Fiduciary Management Advisory Services March 2014 Matthew Mignault Head of Fiduciary Manager Research 4
Components of fees in a fiduciary management mandate Components of fees In our view, it is helpful to separate the fees in a fiduciary management mandate into three (3) components, as follows: Base fiduciary This is essentially the fees the fiduciary manager (FM) charges for providing advice, modelling and implementation. It can include a performance-related element. Investment Other fees In a fiduciary management mandate the investment are paid to the FM as specified in the fiduciary management agreement the FM then pays the underlying investment managers based on the fees it has negotiated with them. There are a number of other fees in addition to what might be included in the fiduciary management agreement. These include custodian fees, transition fees and fees associated with independent oversight of the initial strategy advice as well as the ongoing monitoring of the FM. In this survey we have focussed primarily on the first two components. Typical services in an FM mandate Fiduciary management is a service and the fees for it are reflective of the services required. In our experience, many schemes will have different service needs. As a result, the fiduciary payable by one scheme could be very different than the fees payable by another scheme of similar size. For instance, the fiduciary for a pension scheme where the FM advises the trustees on investment strategy which involves a fixed asset allocation and is only tasked with quarterly rebalancing will be lower than the fees if the same FM designs a flight plan to dynamically re allocate growth type investments to matching type investments as market condition allow and is tasked by the trustees with executing the flight plan on a daily basis. The following is a description of services that we often come across in fiduciary management mandates: Advisory Execution Communication Initial investment strategy advice Implementation of hedging strategy Meetings Annual recalibration of strategy Execution of flight plan de-risking mechanism Performance reporting Design of flight plan Tactical asset allocation Trustee training Generation of new investment ideas Selection/replacement of investment managers 5
Context for survey Hypothetical pension schemes To ensure the survey responses we received from the participating FMs were comparable we created 3 hypothetical pension schemes which we have called Small ( 50m), Medium ( 250m) and Large ( 750m) where, in all cases, the trustees require the following services from their FM: Investment strategy Initial investment strategy advice Flight plan Advice on design of a flight plan which involves gradually decreasing the scheme s asset allocation from the current 60% growth/40% matching allocation to a target allocation of 100% to the matching portfolio as the scheme s financial position improves Delegated execution of investment strategy Execution of the above flight plan with de-risking from the growth portfolio to the matching portfolio based on daily testing of the funded ratio against flight plan parameters, making tactical asset allocation decisions to over/underweight certain asset classes based on the FM s short to mid-term views of the relative attractiveness of various asset classes and selection and replacement of underlying investment managers Meetings Quarterly meetings and reporting to the trustees with periodic trustee training on relevant investment issues In our experience, this service specification would be fairly common. Model investment portfolio Furthermore, to ensure comparability of the fees, we specified the following initial asset mix (model portfolio) which, initially, the trustees would want to maintain: Asset class Benchmark weighting Growth portfolio 60% Developed market equity (active) 30% Emerging market equity 5% High yield debt 5% Emerging market debt 5% UK property 5% Hedge funds 10% Matching portfolio 40% Fixed interest gilts 15% Inflation linked gilts 15% Investment grade corporate bonds 10% Total 100% Initially the trustees would not be interested in hedging the scheme s interest rate or inflation exposures beyond physical holdings of fixed interest and inflation linked gilts. 6
Base fiduciary management fees Base fiduciary Investment Other fees The base fiduciary cover most of the services the FM provides. Generally, this includes the advisory services the FM provides to the trustees in connection with the investment strategy plus the execution of that investment strategy. It also includes the meetings and reports associated with the advice and execution. How are the base fiduciary management fees actually charged? The base fiduciary are typically charged on a percentage of assets basis. The implication of this is that, as/if a scheme s assets increase, the FM will receive a larger base fee (in monetary terms) and vice versa. Figure 1 distribution of base fiduciary (bps) 1, 2 0.40% 0.35% 0.30% 0.25% 0.20% 0.15% 0.10% 0.05% 0.00% Q3 0.36% Median 0.35% Q1 0.28% Q3 0.26% Median 0.25% Q1 0.15% Q3 0.20% Median 0.16% Q1 0.15% Small 50m Medium 250m Large 750m One can see from figure 1 that base fiduciary management fees, measured in basis points (bps), reduce as scheme size increases. For instance, the median fee for the Small scheme is 35bps whilst the median fee for the Large scheme is 16bps. This is what one would expect if you view fiduciary management as a service since a lot of the services required are very similar regardless of scheme size. The distribution in figure 1 is quite interesting and highlights just how competitive the fiduciary management business is. For the Small and Medium sized schemes there were a number of FMs whose base fiduciary were concentrated around the median fee this is why the Median and 3rd quartiles (Q3) are so close together in figure 1. One can also see that for the Large scheme the distribution of fees is around a very tight range with most FMs base fees within 5 bps of each other. In our experience, different FMs are focused on different segments of the market with some FMs specialising in smaller to mid-size schemes and others in the larger end of the market. This is evident in our survey results as some survey respondents indicated they would not be quote for a certain sized pension fund. For smaller pension schemes, a number of FMs have minimum base fees (for instance, one FM has minimum base fiduciary of 100,000 p.a.). However, for the smaller pension scheme that is interested in fiduciary management all is not lost there are FMs that focus on this market segment. 1 We note one FM who participated in our survey was excluded from the above results because the standard expression of their base fiduciary was a base fee plus a performance-related fee. This meant their response was not directly comparable to the other FMs responses. 2 Please see the Appendix for details on interpreting box plots. 7
0-10% 11-20% 21-30% 31-40% 41-50% 51-60% 61-70% 71-80% 81-90% 91-100% Performance-related fees In practice, some FMs base fiduciary include a performance component whereby the overall base fiduciary payable can go up if, during the period in question, the FM is able to meet or exceed certain predetermined criteria. Depending on the FM, these criteria could include the improvement in the pension scheme s funding ratio, an investment return in excess of a certain threshold and could even potentially include qualitative criteria. As can be seen from figure 2 most FMs are willing to accommodate a performance-related base fee approach if the trustees request it (indeed, for one FM surveyed, this is their preferred approach). Figure 2 willingness of FM to incorporate a performancerelated component into base fiduciary 20% FM Insight: Over the past 5 years we have moved away from performance-based fees due to client preferences to make fee structures more simple, transparent and predictable. Restricting our attention to those FMs who are willing to incorporate performance-related fees into their fee models, figure 3 shows that for most of these FMs, a relatively small percentage of their client base have chosen this approach. Figure 3 prevalence of performance-related fees across client base (in FMs who are willing to accommodate a performance-based fee approach) 40% 30% Participating FM 20% 10% 10% 0% 70% Yes Not typical approach, but will adopt it No EY Insight: In our experience, whilst many FMs have indicated they are willing to offer performance-related fees, we are not seeing many trustees who are seeking to structure fees in this manner. 8
Base fiduciary management fees (cont d) Base fiduciary Investment Other fees Fees for interest rate/inflation hedging Part of the standard services provided by a FM would be advice to the trustees around (partially) hedging the pension scheme s interest rate and inflation exposures. The FMs surveyed had differing solutions to execute the resulting hedging policy. In some cases, FMs execute hedging policies via investment in leveraged pooled LDI type funds whilst in others FMs use derivative instruments (for example: interest and inflation swaps). In the former case, the fees for this would simply be the investment associated with the pooled LDI funds whilst in the latter case the FM would charge explicit fees to set up and manage these derivative instruments. Other fiduciary (not covered in the base fee) For most pension schemes, the base fiduciary management fees include almost all of the services the trustees will require (for example: strategy advice, asset/liability studies, execution of investment strategy and reporting). This means that, apart from investment, for an agreed upon level of investment delegation, trustees should not expect to incur any additional fees. As shown in figure 4, the main exception to this is at the outset of the fiduciary management relationship where some FMs will charge transition to transition the assets from existing arrangements. In some cases, the transition management fee only applies when an external transition management firm is used. Figure 4 does the base fiduciary management fee include: 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Initial advice Regular asset/liability studies Yes No n/a Transition manager fees Whilst we have not explicitly considered custodial fees in this survey we note that most FMs will have custodial fees associated with their funds (although many FMs are willing to work with a trustees preferred custodian). 9
Investment management fees Base fiduciary Investment Other fees There are significant differences in the way FMs approach investment management. In most cases FMs will not select individual securities themselves but instead will construct portfolios using the funds of external investment managers. However, some FMs are also equipped to act as the underlying investment manager in their own right and, if instructed to do so by the trustees, will select securities in-house. In all cases, unless the trustees give an explicit instruction to the contrary, the holdings in each asset class will be invested in the FM s best ideas. For example, for developed market equities, the external investment managers chosen would be those managers that the FM prefers based on their research. In practice, from a fees perspective, the trustees pay the FM combined fees equal to the base fiduciary plus the investment. The FM then pays the underlying investment manager the fees it has negotiated with them. Some FMs use a cost pass-through model for investment (whereby they do not make any profit on the investment component of the combined fee). However, for some FMs, this element of their charging structure can be more opaque. Results actively managed model portfolio As figure 5 shows, the investment payable for the model portfolio described on page 6 vary across the FMs surveyed. This variation reflects differences in the FMs preferred external managers and their ability to negotiate favourable investment with these external managers. Unlike base fiduciary where the fees vary inversely with scheme size, this pattern is not evident for investment. Instead, for the vast majority of FMs surveyed, investment (in basis point terms) are the same for the Small, Medium and Large schemes. This is why we only show the results for the Medium scheme in figure 5. This is consistent with the notion that FMs use their bulk buying powers to give all of their clients lower cost access to their preferred investment managers. Figure 5 investment for model portfolio incorporating active management of developed market equities (bps) 1 0.60% 0.55% 0.50% 0.45% 0.40% 0.35% 0.30% 0.25% Median 0.44% Scheme Medium A 250m (N=8) Q3 0.49% Q1 0.34% We note that the investment strategy for our model portfolio is fairly conventional. For a pension scheme that intends to run a particularly complex or esoteric investment strategy they might find that some FMs are constrained in their ability to offer highly customised portfolios on a cost-effective basis. 1 Please see the Appendix for details on interpreting box plots. 10
Investment management fees (cont d) Base fiduciary Investment Other fees Preference of active vs. passively managed portfolios An important factor in the size of the investment management fees is whether the assets are actively or passively managed. We know from experience that some trustees will have a view (sometimes passionate) as to which is a better approach for their scheme. In our experience, most FMs can accommodate trustees preferences for either active or passive management. That being said, in practice, many trustees will not have a strong view as to whether their pension scheme should utilise active or passive management and, when appointing an FM for the first time, would look to their FM for their guidance on this. As figure 6 shows, about half of FMs surveyed have no current preference of active vs. passive management in developed market equity portfolios and only about 30% have a current preference for active management. This result would differ for other asset classes where active management arguably becomes more critical. Figure 6 FM preference for active vs. passive management of developed market equities 30% In terms of the impact of passive management on investment, we also asked FMs to indicate what the investment would be for the model portfolio if the developed market equity exposure (30% of overall assets) was passively managed. As is shown in figure 7 below, the impact of passive management was to reduce the investment in figure 5 by, on average, about 15 bps. Figure 7 investment for model portfolio incorporating passive management of developed market equities (bps) 1 0.50% 0.45% 0.40% 0.35% 0.30% 0.25% 0.20% 0.15% Median 0.27% Q3 0.31% Q1 0.23% 0.10% Medium 250m 50% 20% Active Passive No preference EY Insight: As assets under management at FMs grow, we would expect that they will be able to negotiate lower investment with their preferred investment managers. We expect that this will translate into lower investment within FM mandates. 1 Please see the Appendix for details on interpreting box plots. 11
Base fiduciary plus investment Base fiduciary Investment Other fees As noted, in most situations, the required ongoing fees for an FM mandate is the base fiduciary plus the investment. Figures 8 and 9 respectively show these combined fees for our sample schemes adopting the model portfolio with actively/passively managed developed market equity exposure respectively. Figure 8 combined base fiduciary plus investment (bps) (incorporating active management of developed market equities) 1 0.90% 0.85% 0.80% 0.75% 0.70% 0.65% 0.60% 0.55% 0.50% 0.45% Q3 0.77% Median 0.71% Q1 0.69% Q3 0.69% Median 0.63% Q1 0.56% Q3 0.67% Median 0.57% Q1 0.50% Figure 9 combined base fiduciary plus investment (bps) (incorporating passive management of developed market equities) 1 0.70% 0.65% 0.60% 0.55% 0.50% 0.45% 0.40% 0.35% 0.30% 0.25% 0.20% Q3 0.64% Median 0.59% Q1 0.57% Median, Q3 0.52% Q1 0.47% Q3 0.48% Median 0.42% Q1 0.40% Small 50m Medium 250m Large 750m We find these results to be particularly interesting in that those FMs that had the higher base fiduciary tended to have lower investment for the model portfolios and vice versa. Again, we emphasise that the combined base fiduciary plus the investment will be heavily dependent on the services required of the FM and the investment strategy followed. 0.40% Small 50m Medium 250m Large 750m EY Insight: When comparing fiduciary managers it is important to consider both the base fiduciary and the investment of the FM s preferred investment managers. In making this comparison it is important to understand any differences in the fiduciary management services provided or their proposed investment strategies. 1 Please see the Appendix for details on interpreting box plots. 12
Base fiduciary Other fees Investment Other fees In a fiduciary management mandate, the trustees may require the support from a third party advisor in certain areas. This support is entirely optional but, especially in relation to reviews of an FM s performance, is becoming best practice. Independent oversight of the FM s initial strategy advice When an FM is first appointed, one of the earliest activities is typically a wholesale review of the existing investment strategy. This is a critical phase in the relationship as it will heavily influence the results that follow. In our experience, in some cases, trustees will seek advice from an independent third party to give them greater comfort that the FM s initial strategy advice is both practical and robust, fits with the trustees objectives and is accurately reflected in the fiduciary management agreement. Independent third party monitoring of the FM s performance In a fiduciary management mandate the FM will have the delegated authority to make a number of investment decisions. For instance, it is common for trustees to delegate authority to the FM to make decisions in the following areas: Selection and replacement of external investment managers Tactical asset allocation Tactical decisions in connection with hedging of interest/inflation exposures The decisions the FM makes in the above areas will have an impact on the scheme s funded position and risk levels. Many trustees are turning to an independent third party advisor to help them monitor the FM s performance in these areas ultimately to help them form a view as to whether the FM is providing value for money. Other quantitative metrics such as control of risk and competitiveness of fees are also considered as part of these reviews. Increasingly, we are finding that reviews of an FM s performance also take into account qualitative criteria (for example: service levels, quality of reporting). These performance reviews are analogous to the investment performance reviews that are established best practice in traditional investment structures. EY Insight: Periodic reviews of the FM s performance, whilst optional, are quickly becoming recognised as a best practice governance activity. The exact form and content of these reviews will vary but the central theme is that they help trustees form a considered view of whether the FM is providing value for money and not taking undue risks from either an investment or operational perspective. 13
Getting help Against the backdrop of an ever-developing fiduciary management market and varied solutions, obtaining independent help can be very beneficial. EY is able to help trustees and sponsors in: Identifying the right investment governance solution Running a fiduciary management selection exercise For further information, please visit www.ey.com/fiduciarymanagement or contact: Assisting with the initial appointment of a fiduciary manager Monitoring a fiduciary manager s performance Iain Brown Partner Tel: +44 20 7951 7546 Mobile: +44 7977 023 389 Email: ibrown1@uk.ey.com Matthew Mignault Senior Manager Tel: +44 20 7951 7630 Mobile: +44 7827 257 370 Email: mmignault@uk.ey.com Tony Martinez Manager Tel: +44 20 7951 2241 Mobile: +44 7920 822 527 Email: tmartinez@uk.ey.com Christopher Bown Director Tel: +44 20 7951 3231 Mobile: +44 7730 733 861 Email: cbown@uk.ey.com Adam Poulson Senior Manager Tel: +44 113 298 2424 Mobile: +44 7876 397 927 Email: apoulson@uk.ey.com Sean Bottomley Director Tel: +44 113 298 2327 Mobile: +44 7740 923 265 Email: sbottomley@uk.ey.com Philip Wheeler Senior Manager Tel: +44 141 226 9557 Mobile: +44 7786 313 701 Email: pwheeler@uk.ey.com Vicky Paramour Senior Manager Tel: +44 20 7951 1458 Mobile: +44 7789 030 921 Email: vparamour@uk.ey.com Rob Heaton Senior Manager Tel: +44 113 298 2519 Mobile: +44 7767 494 887 Email: rheaton@uk.ey.com 14
Appendix: how to read a box plot We have used several box plots throughout this document to illustrate the spread of survey responses. In particular, the box plots show at a glance the range of the middle 50% of responses. The example below explains how to interpret the graphs. Example investment for model portfolio incorporating active management of developed market equities (bps) 0.60% 0.55% This is the maximum value observed 0.50% This line represents the 75 th percentile and is labelled Q3 Q3 0.49% The highest 25% of values are above 0.49% pa 0.45% 0.40% This line represents the median, i.e. the 50 th percentile Median 0.44% The middle 50% of values are between 0.34% pa and 0.49% pa, i.e. between Q1 and Q3 0.35% 0.30% This line represents the 25 th percentile and is labelled Q1 This is the minimum value observed Q1 0.34% The lowest 25% of values are below 0.34% pa 0.25% Scheme Medium A 250m (N=8) 15
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