The pension gap

With its national parks and miles of stunning coastline, the English county of Devon has obvious attractions to pensioners. But there are less obvious attractions, too.

Devon’s pension fund pays relatively little in fees to investment managers compared with other English counties – yet the performance of the fund is in line with its peers. Staffordshire’s pension fund pays more than three times as much, for a fund that is almost identical.

Devon v Staffordshire

Similar funds - different costs

The difference, revealed by a ground­breaking study based on annual reports of the 100 local authority pension plans in the UK, provided to the FT by Investor Data Services, a London consultancy, was not unusual. The most expensive quarter of funds paid an average of more than four times as much for investment management as the cheapest quarter.

With returns falling, fund managers across the world face complaints about fees and a lack of transparency. Active managers are under pressure to justify their fees in the face of growing competition from cheaper passive funds that merely track benchmark indices. These findings will fuel debate over how UK council pensions should be run and whether funds are sufficiently transparent.

The council’s funds are managed by some of the biggest names in global asset management. But it is impossible from public data to ascertain the fees and commissions each charge.

UK council plans, which managed £187.3bn between them at the end of the last financial year, are typical of many across the world – but the UK’s public-sector disclosure rules allow a look at fees that might stay hidden.

Neither Staffordshire nor Devon is exceptional; they are an interesting example because they appear similar. They are the same size: Devon had £2.68bn in March 2012, against £2.62bn for Staffordshire. They have a similar spread of assets in fixed income, equities and property, with a little money given to hedge fund managers. Both hold the same top three stocks (Royal Dutch Shell, Vodafone and HSBC) while three fund managers work for both counties. They follow the same public-sector procurement rules.

Yet Staffordshire paid £7.152m for fund management in 2011-12, while Devon paid £2.669m. And Staffordshire’s bill for administration came to £2.033m, while Devon paid £1.225m.

Over the preceding eight years, Devon paid £3.9m less in investment fees per year and £850,000 less in administration fees. That means Staffordshire paid £38.2m more than Devon for essentially the same job. In overall return over the past decade, Devon has gained 6 per cent a year and Staffordshire 5.7 per cent – in line with the average council, according to State Street Investment Analytics.

Staffordshire county council said: “Hymans Robertson, the actuarial and investment consultancy, has conducted extensive analysis of fee statistics for local government pension schemes and has confirmed that our level of fees are consistent with those paid by other authorities.

“Fund structures can be very complex, so even if they appear to be superficially the same, without detailed analysis it is very difficult to make a ‘like for like’ comparison.”

Council annual reports do not offer benchmarks for costs. It is only by collating cost data, often buried in footnotes, that discrepancies emerge.

One reason anomalies develop is the length of the value chain for pensions. The final return to investors is stated but it is unclear how much this has been reduced by avoidable fees.

Hymans Robertson, which could not comment on individual cases, said that funds the size of Devon or Staffordshire should be paying fees of 25 to 35 basis points. Anything lower would imply that they were “not fully disclosing fees”. This could be because they invest in pooled funds “where the manager fees are charged within the fund and reflected in the unit price rather than paid explicitly” by the council. (Devon had a 6 per cent allocation to pooled funds in its latest report). High charges could stem from “funds of funds”.

Officials at Devon said they doubted that a cost benchmark would be useful because strategies vary widely.

Another explanation for the discrepancies is that not all the necessary data are available to the public. The costs that funds’ investment managers incur in buying and selling stocks are shown in report footnotes (Staffordshire’s managers spent £3.28m on commissions, Devon’s £959,000). Commission charges vary hugely across the sector, according to IDS’s data.

When Christopher Sier, an independent consultant, built a database on commissions using freedom of information requests, he estimated average portfolio turnover at about 120 per cent a year – which seemed high as many funds were passive. But firm conclusions were impossible because information was redacted, often including the names of both the fund managers and their brokers.

Local authorities are already attacking costs. Some are forming consortiums to award contracts or planning to merge their administration. Concentration of managers is falling, with the top five managers accounting for 38 per cent of externally managed assets, from 56 per cent a decade ago.

They are also moving from active managers to passive index-trackers, which now account for 24 per cent of assets, according to the WM UK Local Authority Fund Annual Review – up from 14 per cent 10 years earlier.

Some are negotiating more aggressively with their fund managers. Linda Selman, of Hymans Robertson, said: “They simply ask managers what fee concessions they can make and explain the environment they are living with. That’s had a pretty good level of success. When managers have been put under pressure they’ve offered maybe 10 per cent of the fee.”

Some also negotiate on outcomes. One small council cut its investment management fees to only 0.05 per cent in one year because it had entrusted all its assets with one fund manager, in return for a rebate if performance dropped below an agreed benchmark. The manager failed to meet its three-year benchmark and forfeited fees.

The IDS research suggests pension funds will need to offer far more transparency about their charges – and that fund managers can look forward to even more aggressive negotiations in future.