Furthermore, bfinance argues little attention is paid to the ability of institutions to negotiate active fees downwards. “A lot of academic research into active versus passive management uses mutual fund data regarding fee levels,” Jones stipulates. “This doesn’t take into account the considerable discounts institutions are able to negotiate for active. In the past few months we have seen fees negotiated downwards in excess of 40bps for active management fees. The data we have gathered suggests it may be possible to significantly reduce the fees assumed in the Hymans Robertson analysis, without changing the distribution of mandates.”
The Hymans Robertson report does, however, place significant emphasis on the benefits of using collective structures to generate savings in investment costs.
HOW ACTIVE IS ‘ACTIVE’?
Importantly, not all active managers are created equal, which has been shown to make a significant difference to their value proposition. SCM Private found nearly half (46%) of UK equity funds marketed as active funds of being ‘closet indexers’. Their analysis of over £570bn of UK and US funds revealed on average 40% of each fund is identical to the same index the fund is aiming to beat, making investment returns for these funds highly unlikely to achieve the initial objective first marketed to investors.
Fees were often three times those of typical index funds. SCM Private estimates UK investors could have saved around £3bn in UK and overseas equity fund fees over the last five years by choosing a low cost index fund over the various underperforming closet indexers.
Furthermore, SCM Private’s research found where only the minority (less than 50%) of managers’ portfolio holdings were the same as the index, the majority have outperformed the index by 1.6% annually on average. Only 28% of these funds underperformed the index over five years. Where 50% or more of a fund’s holdings were the same as the index, 88% underperformed the index over five years.
PAY CLOSE ATTENTION
With this research in mind, Lauren Juliff, head of institutional UK at Skagen Funds, says: “The prevalence of closet indexation in the UK is something the LGPS and all institutional investors need to analyse and avoid in their efforts to achieve value for money.
“Fees are an important consideration for pension schemes and transparency is key to understanding and comparing manager fees, but ultimately what matters is whether the investor receives good value for money characterised by superior investment results net of all fees and costs.”
The need for more detailed analysis of the value individual mandates offer was also emphasised by Helen Forrest, policy lead: DB, at the National Association of Pension Funds (NAPF), who says: “We are concerned the Hymans Robertson analysis was too narrow in scope and did not address the potential savings from internal management, including direct investment.
“Instead of focusing purely on reducing costs,” she continues, “the NAPF recommends the government focuses on identifying good and bad performance within the LGPS at a fund level, with a view to bringing poorly-performing funds up to standard through targeted regulatory interventions.”
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