| Pension funds fees rise by over 50% |
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| Thursday, 28 February 2008 | |
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Pension funds around the world are paying on average 50 per cent more in fees than they were five years ago.
The research by global consulting firm Watson Wyatt found that fees now average around 110 basis points compared with around 65 basis points in 2002, with the vast majority of these costs being paid in fees to external investment managers and brokers. Focus on alpha Paul Trickett, European head of Investment Consulting at Watson Wyatt, said that one of the main reasons for this upward cost spiral was investors' focus on 'alpha', which has increased their appetite for alternative assets. “Investors have naturally assumed that they are paying these fees to reward manager skill, but in many cases they are wrong,” he added. In a research note entitled 'A fairer deal on fees', the firm said that many pension funds had been paying 'alpha' fees for 'beta' performance because the main driver of returns in recent years had been the strength of the markets. This has encouraged investment managers to leverage their portfolios to boost returns, which meant that investors were often paying for leveraged beta, market returns multiplied by gearing. Flaws Trickett explained that this was a good deal for investment managers, but not necessarily for their investors. “While we strongly believe managers should be fairly compensated, fees are currently too high for the value they deliver particularly as we enter a lower-return environment,” he said. He added that performance fees introduced to align interests had been less than effective because they were generally poorly designed and tipped in managers' favour. In the note the firm identifies a number of flaws in investment manager fees. Annual performance fees can amount to a free option for the manager, as the upside is uncapped but the downside is limited to the base fee. Fees can also be paid on money waiting in cash to be drawn down for investment. Many leveraged real estate managers charge fees on the gross exposure rather than committed capital. Fees charged by fund of funds can use a combination of these flawed approaches and in many instances lack transparency. Ideal fee structure Trickett said that many trustees had unwittingly paid away the vast majority of their 'alpha' in fees in the recent past, surprisingly even when their fund managers had performed particularly well. According to the firm an ideal fee structure should have a low base fee to cover costs and a performance fee which should be calculated over longer periods - typically three to five years -, include 'ghost' years and have hurdles and high-water marks. In addition, total fees should never be more than 50 per cent of alpha and costs should formally be included in funds' risk budgets. It also says that fee structures should not be standardised across the industry in view of the increasing diversity of investment strategies and mandates. Watson Wyatt described it as a complex area, but said that this did not mean it should be glossed over. “Too much value has already been allowed to leak away,” Trickett remarked. He said that there were signs of change as we move into a different market environment where many managers would no longer be able to justify their charges without beta to bail them out. “In future, active managers that wish to win pension fund money will need to offer them a fairer deal,” Trickett concluded. Related articles
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