A Practical Guide to Pension Fund Investment Costs

December 18, 2016 | Posted in FREE Guide to Pension Fund Costs | By

To help trustees and governance professionals.

The landscape for cost and charge discovery is rapidly changing for the better due to factors such as improving investor awareness, calls for increased cost transparency by industry bodies, regulatory and market initiatives and pressure to reduce pension fund deficits. The recent Asset Management Market Study – Interim report by the Financial Conduct Authority (FCA) and the potential impact it could have on institutional investors and their future governance arrangements is a good case in point.

The purpose of this guide is to assist the governance process in measuring and managing transaction costs, pooled fund costs and segregated mandate costs. The guide has been written in collaboration with Sunil Chadda, an experienced investment costs specialist and we believe it is the most comprehensive and detailed guide to investment costs and Value for Money available in the UK today.

Report Content:

  • Typical sources of investment costs for pension funds and other asset owners
  • How to evaluate Value for Money
  • Use the CLERUS self-assessment Check List to gauge the potential for hidden, or excess, investment costs in your fund
  • Get key insights and practical examples of where to find costs and charges

Henrik Pedersen, Managing Partner & Co-Founder of CLERUS said:

“The onus is now on pension fund trustees and governance professionals to demand transparency on all costs and charges related to the management of retirement funds and to assess if they provide ‘Value for Money’. We hope this Guide will be a useful tool to assist them in this pursuit.”

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CLERUS is an independent consultancy. As experienced investors we bring professional and value-added investment governance expertise directly to pension schemes and other asset owners.

We add value to decision-makers because we are able to provide informed, independent and objective investment analysis free of any bias. This includes a full review and clarification of all investment related costs, including transaction costs, and their impact on investment performance.

We also help review and improve the performance of service providers who are not being independently or appropriately assessed. Increased transparency is created which helps identify the investment activities that provide value-for-money, and those that are detracting value. This reduces cost and improves investment outcomes.

A Simple Way to Compare Pension Fund Deficits – Case study LGPS

February 29, 2016 | Posted in Benefits of Transparancy | By

Transparent Methodology Reveals Larger Than Reported Variations in LGPS Valuations.

In this report, CLERUS, in collaboration with Dr Iain Clacher from Leeds University Business School, sets out a methodology for comparing LPGS valuations on a council-by-council basis using public data and transparent calculations. The use of a standard portfolio-based approach allows stakeholders, including taxpayers, to identify schemes that are being transparent and prudent in their approach to valuation. It also enables the public to compare all schemes on a consistent basis, which has not been possible to date.
We believe that this approach is an improvement to existing proposals and could be implemented in time for the 2016 valuations.

Report Summary:

  • Overall LGPS deficit does not change materially if the long-run equity risk premium is set at 3% per annum across all 88 local authorities in England and Wales, however, if our analysis is representative across LGPS the funding levels of individual schemes could change significantly:
      -Worcestershire could see improved funding level of 15% (to 84%) / Deficit decrease of £450m
      -Berkshire could see reduced funding level of 26% (to 49%) / Deficit increase of £1.1bn
  • 1% change in performance assumptions equals a 9% or £35bn change in overall LGPS deficit
  • Extension of recovery periods from 2010 to 2013 valuation generated a ‘paper gain’ of £9.2bn

With the 2016 valuation due at the end of March, setting out a transparent methodology allows all stakeholders to make a considered judgement about the assumptions used in past and future valuations and whether they are prudent. This is of particular importance as the forthcoming pooling of LGPS needs clear and comparable data to ensure that potential mergers are going to be effective and deliver value for the taxpayer.

Overall, we find that the aggregate deficit for LGPS does not change materially if the long-run equity risk premium is set at 3% across the board. However, if our analysis is representative for individual schemes, we find that the funding position of a number of authorities could change and in some cases significantly. This information is of particular importance if a local authority with a strong funding position is asked to merge, and therefore in effect subsidise another, where the deficit could be much higher than reported if realistic and consistent assumptions were used.

TABLE 1: Impact on overall funding levels from applying uniform return assumptions
TABLE 1 - A Simple Way

The recommendation of this report are:

  • LGPS valuations should be made comparable and shown for a range of similar performance assumptions so that stakeholders can assess the funding risk for different scenarios.
  • A transparent portfolio-based valuation approach should be used where the discount rate is a function of the riskiness of the portfolio.
  • Excess performance assumptions over and above standard long-run risk reward trade-offs should not be allowed as there is no free lunch in financial markets over long time horizons
  • A government actuary should decide what performance assumption criteria should be used for all LGPS. We suggest that the values for excess expected return on equities over Gilts be based on 0%, 1%, 2% and 3%.
  • The £ and % impact of recovery period extensions should be specified in the valuation report so that stakeholders can evaluate the extent to which each council has sought to improve the funding position from these kind of paper gains.

Dr Iain Clacher, Leeds University Business School said:

“There is a need for a consistent approach to valuation across LGPS to ensure that there can be a true assessment of value for money for the taxpayer. The present myriad of approaches makes it difficult for straight forward assessment and benchmarking to take place and this is not good for the effective management of public money.”

Henrik Pedersen, Managing Partner & Co-Founder of CLERUS said:

“The aim of this report is to illustrate how relatively straightforward and beneficial it is to set out a transparent methodology which allows all stakeholders to compare LGPS valuations on a consistent basis, which has not been possible to-date. We hope our recommendation will be included in the 2016 valuations.””

To preview the report “A Simple Way to Compare Pension Fund Deficits – Case study LGPS” click here

To purchase a hard copy of the full report including estimated rankings for all 88 Local Authorities in England and Wales, click here.

CLERUS is an independent consultancy. As experienced investors we bring professional and value-added investment governance expertise directly to pension schemes and other asset owners. We add value to decision-makers because we are able to provide informed, independent and objective investment analysis. We help review and improve the performance of service providers who are not being independently or appropriately assessed. Increased transparency is created which helps identify the investment activities that provide value-for-money, and those that are detracting value. This reduces cost and improves investment outcomes.

Why trustees should challenge their advisers (Professional Pensions)

September 24, 2015 | Posted in In the news | By

Helen Morrissey finds that Trustee boards stand to gain a lot by adopting a more challenging stance with their advisers

At a Glance
•Concerns have been raised that trustees are not challenging their advisers enough.
•Advisers should be able to deliver key points of strategy in a way trustees can understand.
•Trustees should question whether the investment strategies they are put into are right for their specific scheme.

“Speaking at the Professional Pensions Defined Contribution (DC) conference, The Pensions Regulator’s executive director of DC Andrew Warwick-Thompson reiterated concerns that trustees may not be managing their advisers effectively”

Such an approach can also pay dividends when it comes to implementing new investment strategies according to Clerus founder Henrik Pedersen. Like Wilding, Pedersen believes advisers need to make it clear to their clients why certain investment strategies have been chosen as well as highlighting the conditions under which the strategy might come under pressure.

To read the full article from Professional Pensions please click here: http://www.professionalpensions.com/professional-pensions/feature/2426746/why-trustees-should-challenge-their-advisers

The Price of Short-Term Advice: Performance Attribution of Investment Advisors using LGPS Data

November 17, 2014 | Posted in The Hidden Cost of Poor Advice | By

Conflicts of Interest Cost LGPS £6.2 Billion Over 10 Years.

In the first ever report of its kind CLERUS analysed Local Government Pension Schemes (LGPS) performance data to quantify the economic benefits of the various investment advisory alternatives used by Schemes. This is the first time it has been possible to provide transparency in this important area, across a well-defined pool of capital with similar long-term objectives. The analysis demonstrates how simple performance measurement and attribution can provide valuable insights which can lead to straightforward improvements to investment governance and performance.

Report Summary:

  • True cost of investment consulting advice to LGPS users is at least 0.5% or £740m per annum This represents a factor of around 50 times the headline fees over the past 10 years
  • Separating providers of actuarial services and investment advice added 0.1% to annual returns
  • Independent advisors have not been able to offset the cost of consultants’ conflicts of interest
  • No significant difference in performance across main consultants measured on annual return or manager selection over past 10 years (all detract value)

This analysis reveals systematic value detraction across portfolios from what are well-flagged conflicts of interest inherent in investment consultants’ business models that are not being effectively managed. This is an unintended consequence of current regulation which helps sustain these high costs to pension funds, because the ‘requirement to take advice’ has taken precedence over the optimisation of performance via a sensible and long-term investment strategy.

CLERUS’ research demonstrates that hiring a consultant to advise or manage investments is not a substitute for good investment governance or for the practical and applied investment expertise required to deliver desired outcomes. Investment recommendations are obviously made with an objective to improve results, but the key to justifying short-term investment activity must come with the requirement to demonstrate positive value, when compared to a more stable and long-term investment approach.

The recommendation of this report is that regulations are modified to promote clarity and transparency as better regulatory principles. This would allow trustees and investment boards to make informed decisions and focus on what they are best at. In addition, we suggest that trustees find ways to improve measurement of consultants’ impact on decision-making and take urgent steps to offset the cost of the conflict of interest – either by adding investment professionals who are able to challenge advice effectively (to reduce short-termism) – or by starting to unbundle the investment advisory services they receive.

Henrik Pedersen, Managing Partner & Co-Founder of CLERUS said:

“Up to now, due to the lack of transparency in this area, it has been difficult for Schemes to assess the full cost of investment consulting advice on fund performance.”

“Without this important information there has been little financial incentive for Schemes to challenge what has been perceived as a relatively small cost of consultants, the use of whom has been forced upon them by the regulatory framework.”

“However, this analysis suggests that prioritising performance assessment based on headline cost can be misleading because the investment decision-making that follows investment advisors’ recommendations is the single biggest factor in determining investment outcomes”

“Significant time and effort has been spent trying to identify winning investment managers and strategies, however this process has instead led to systematic value detraction. This report implies that there is massive scope to improve the performance of investment decision-making without the need to change portfolios or taking on any more investment risk.”

“The one-stop shop advisory model where consultants both recommend, benchmark, monitor and manage relations with investment managers may seem a sound and convenient proposition, but it transpires to have been bad governance due to the inherent lack of transparency and inability to assess properly the value added. It also disassociates decision-makers from key parts of the investment process.”

To read the full report “The Price of Short-Term Advice: Performance Attribution of Investment Advisors using LGPS Data” click here

CLERUS was founded to offer independent senior investment management, governance and decision-making expertise to Pension Funds or other asset owners looking to evaluate the efficiency of their current investment management process.

CLERUS co-founders Henrik Pedersen, MBA and Richard Rothwell, FSIP, ASIP are both seasoned financial experts with many years of applied institutional investment experience, which they recognise could be of value to those pension-fund investment-decision makers, who might lack the applied investment experience to question the investment advice they receive.

CLERUS investment governance and performance review process been has developed and successfully deployed to evaluate and improve the performance of investment decisions within leading investment firms and over many years.

Is there a problem with benchmarking multi-credit? (Professional Pensions)

November 7, 2014 | Posted in In the news | By

Stephanie Baxter finds there are concerns over how the performance multi-credit strategies is measured

“Multi-credit is the new buzz word for asset managers and consultants. They say these strategies help protect against future interest rate rises and still produce yield as the credit cycle comes to an end.., however strategies are typically benchmarked by a basic cash-like or Libor index, or more commonly cash plus 1%, 2%, 5% and so on..”

Clerus managing partner and co-founder Henrik Pedersen believes the use of cash-like benchmarks should be of concern to trustees as they do not reflect the risk in multi-credit: “Cash plus 3% seems very innocent but you’re potentially buying a time bomb.

He also argues that increasing the cash plus benchmark “doesn’t mean anything all” as it doesn’t show whether the manager has done well over a long period”

To read the full article from Professional Pensions please click here: http://www.professionalpensions.com/professional-pensions/news/2380200/is-there-a-problem-with-benchmarking-multi-credit

‘Accounting trick’ hid £5bn in poor performance of alternatives (Professional Pensions)

October 7, 2014 | Posted in In the news | By

The report said: “This raises important professional and ethical questions around the integrity of investment benchmarks for fund managers. It also undermines basic performance assessment principles and leads to excess incentive fees being paid to these investment managers by the scheme and tax payers.”

To read the full article from Professional Pensions please click here: http://www.professionalpensions.com/professional-pensions/news/2374306/-accounting-trick-hid-gbp5bn-in-poor-performance-of-alternatives

Study: poor alts benchmarking hides £1.1bn of underperformance (Pensions Expert)

October 6, 2014 | Posted in In the news | By

A report released today finds that inappropriate benchmarks used by local authority pension funds and their advisers for alternative investments have artificially flattered performance, with its authors blaming a governance failure in the sector.

To read the full article from Pensions Expert please click here: http://www.pensions-expert.com/Investment/Study-poor-alts-benchmarking-hides-1.1bn-of-underperformance

Mis-selling of Alternatives by Investment Consultants? A Review of Methods Used to Promote Alternatives and Dress-up Performance

October 6, 2014 | Posted in The Hidden Cost of Poor Advice | By

Promotion and Benchmarking of Alternatives by Consultants Questioned: £5bn Underperformance in LGPS revealed.

CLERUS today released a new report which reveals that investment consultant’s promotion of alternative investments to LGPS does not stand up to proper scrutiny. It also raises important professional and ethical questions around the integrity of the performance benchmarks used to assess, and remunerate, alternative managers. Finally, it also highlights the risk to performance where decision-makers lack the expertise to properly challenge the ‘expert’ advice given to them.

Report Summary:

  • Performance assumptions used to promote alternatives to Local Authorities (LGPS) do not stand up to proper scrutiny and are inconsistent with realised past performance
  • Lack of integrity of alternative benchmarks has ‘hidden’ 0.5% per annum, or £ 5 billion in poor performance over 10 years, excluding excess incentive fees paid on below target performance
  • More than £20 billion worth of alternatives and absolute return products benchmarked, and remunerated, inappropriately using cash-like benchmarks in LGPS alone

LGPS regulations require administering authorities to take ‘proper advice’ when making investment decisions. However ‘proper’ is not well defined and does not oblige LGPS to scrutinise the quality of advice prior to making investment decisions. The report highlights the need for improved governance in this area and illustrates why this should include scrutiny of the risk and return assumptions used in various asset-liability simulations to promote alternative investments.

UK consultants’ recommendations also appear to be going against the tide of industry leaders. Examples include California Public Employees’ Retirement System (“CalPERS”) and their decision to divest from hedge funds stating excessive cost and complexity, and the decision in 2013 by the £73bn Danish Labour Market Pension Fund (ATP) to close down its own $1.9bn ‘alpha’ program citing that it had become time-consuming and expensive.

In the event that the original LGPS reform proposals were carried through, Local Authorities would still end up paying £301 million of annual fees, and 58% of total fees, to an 11.5% allocation to alternatives. However, as the data has shown, these alternative investments have historically provided lower return than bonds or equities, and were achievable by simple de-risking.

The dressing-up of investment performance by setting alternative performance benchmarks too low leaves financial intermediaries as winners, while plan sponsors and tax payers lose out.

1) Local Authorities are more likely to be able to report ‘above benchmark performance’
2) Investment advisors can finally report that their ‘buy-rated’ managers beat benchmark
3) Investment managers earn higher fees (including potential performance fees) for longer as their performance looks better than it is and cannot be assessed correctly

Henrik Pedersen, Managing Partner & Co-Founder of CLERUS said:

“The attraction of alternatives is predicated on the ability of consultants to identify the small percentage of managers who might be able meet the unrealistic risk and return assumptions into the future. However, actual performance data published over the last decade in both traditional and the much more complex alternative assets, suggests that this is an unlikely proposition.”

“A typical transition from equities to alternative managers requires the selection of between three and five additional managers, and subsequent monitoring. This is good business for investment consultants, however, as the data have shown, it is has not been so good for LGPS or taxpayers.”

“The report asks a simple question: Why are these products being promoted as providing equity-like returns, but benchmarked and remunerated against cash-like benchmarks?”

“The potential monetary impact and scale on plan sponsors and taxpayers from the lack of integrity of performance benchmarks used to assess and remunerate managers and advisors raises important professional and ethical questions.”

“We recommend that local authorities, and trustee boards, invest to acquire the expertise to challenge the advice they receive from their consultant, before taking any investment decisions. The pay-back of a small investment in improved governance and transparency will be fast and any costs will be far outweighed by the benefits of better investment returns.”

To read the full report “Mis-selling of Alternatives by Investment Consultants? A Review of Methods used to Promote Alternatives and Dress-up Performance” click here

CLERUS was founded to offer independent senior investment management, governance and decision-making expertise to Pension Funds or other asset owners looking to evaluate the efficiency of their current investment management process.

CLERUS co-founders Henrik Pedersen, MBA and Richard Rothwell, FSIP, ASIP are both seasoned financial experts with many years of applied institutional investment experience, which they recognise could be of value to those pension-fund investment-decision makers, who might lack the applied investment experience to question the investment advice they receive.

CLERUS investment governance and performance review process been has developed and successfully deployed to evaluate and improve the performance of investment decisions within leading investment firms and over many years.

Bad advice costs more than money (Pensions Insight)

July 9, 2014 | Posted in In the news | By

LGPS schemes could make vast savings if they improved their governance, according to new research from CLERUS.

Bad advice comes at a price, and now that has been quantified.

LGPS schemes have suffered a loss of £17bn thanks to poor decision making over the last ten years, according to new research from CLERUS. The study found that the vast majority – more than 90% – of LGPS funds do not comply with the Myners Principles relating to good governance …

To read the full article from Pensions Insight please click here: http://www.pensions-insight.co.uk/bad-advice-costs-more-than-money/1474115.article

Uncovering the Investment Performance Drivers of Local Government Pension Schemes

June 23, 2014 | Posted in The Hidden Cost of Poor Advice | By

Increase in LGPS pension contributions directly linked to poor investment recommendations.

CLERUS today released a report revealing that more than 60% of Local Government Pension Schemes (LGPS) performance variation is directly linked to investment recommendations, which are not being measured and assessed by more than 90% of Schemes. These are:

1. The performance of manager selection relative to the Scheme specific benchmark
2. The percentage allocation to assets classified as “alternative”

To read the full report click here

For the majority of Schemes, investment decisions have become little more than the implementation of recommendations made by their investment advisors. However, neither recommendations nor their impact (on investment performance and contribution levels) are being measured or assessed by most Schemes.

“Our research show that the increase in employer contributions is, to a large extent, due to the crystallisation of the £17.3 billion ‘hidden cost of poor advice’ that has not been measured or reported in the past”, said Henrik Pedersen, Managing Partner & Co-Founder of CLERUS

The report also evaluated the current LGPS reform proposal that it could be beneficial if schemes were ‘forced’ to adapt a high percentage of passive management for traditional assets, while still being allowed to invest in alternative investments. CLERUS finds that this is unlikely to yield the desired results because the overall investment governance issues will remain unresolved.

Henrik Pedersen added “It is the improvement of investment outcomes rather than potential ‘cost-savings’ alone that really matter for the taxpayer. In our view this will be best achieved by the proactive enforcement of Myners across all Schemes, by the Government”

Report Summary:

  • CLERUS two-factor explanatory model reveals that more than 60% of performance variation between LGPS is directly linked to the outcome of manager selection and alternative asset allocation
  • Up to 50% of LGPS performance outcomes can be explained by the performance of manager selection activities (average impact of -1.1% over the last 5 years)
  • Up to 35% of LGPS performance outcomes can be explained by their alternatives allocation. For each 10% allocation to this asset class, investment performance was reduced by 0.5% per annum over the last 5 years
  • CLERUS’ analysis suggests that the current LGPS proposal of ‘forcing’ Schemes to adapt a higher percentage of passive management, while still being allowed to invest actively into alternative investments, is unlikely to deliver the intended results

Conclusion:

  • Direct link between the performance drivers identified in this report and the failure to measure and assess the effectiveness of investment decisions and advice
  • The results will make it difficult for Schemes to claim good stewardship of funds without full performance measurement in accordance with Myners
  • Expected ‘cost savings’ achieved by increasing the percentage of passive management will most likely be offset by additional risk-taking in ‘active’ alternative investments
  • Making transparent performance assessment and reporting a regulatory requirement is the cheapest and most effective way to improve investment performance in LGPS

CLERUS was founded to offer independent senior investment management, governance and decision-making expertise to Pension Funds or other asset owners looking to evaluate the efficiency of their current investment management process.

CLERUS co-founders Henrik Pedersen, MBA and Richard Rothwell, FSIP, ASIP are both seasoned financial experts with many years of applied institutional investment experience, which they recognise could be of value to those pension-fund investment-decision makers, who might lack the applied investment experience to question the investment advice they receive.

CLERUS investment governance and performance review process has been developed and successfully deployed to evaluate and improve the performance of investment decisions within leading investment firms and over many years.