John Clancy & Michael Johnson on LGPS fund management costs
0Our regular blogger, Cllr John Clancy of Birmingham City Council, recently submitted a post on LGPS investment costs and the scarcity of pension fund investment in UK infrastructure. We asked Michael Johnson, Research Fellow of the Centre for Policy Studies to follow up with his thoughts on the same topic. Below are John and Michael’s solutions to cutting costs in LGPS fund management.
Cllr John Clancy, Birmingham City Council
It’s time for a ‘feebate’.
That’s a fee-rebate on fees paid by the poor to the very wealthy who run the world’s financial markets.
It’s time they were paid back to invest in real businesses, real industry, real homes and infrastructure; and here in the UK, especially. While a Robin Hood transactions tax would undoubtedly be a good thing, there is a much more direct way of cutting our cloth which is an antidote to austerity cuts.
Recently in this column, I pointed out that, based on OECD figures, a conservative estimate of the amount of money each year paid in fees by the world’s pension funds to their ‘investment managers’ (accountants, lawyers, consultants, traders, bankers etc.) was probably in the region of $150Billion. That’s every year.
Much of the world’s financial markets are actually made up of public sector pension fund assets in investment. $30tr is invested in pension funds the world over, according to the OECD, and this is significantly and massively made up of the world’s public sector pension funds. About 70% of the world’s 300 largest pension funds are the public sector ones.
Whether it is the various Japanese state workers’ funds of $1.8tr (these figures are usually denominated in dollars, so I’ll continue with that) or the Ontario Teachers’ pension fund of $116bn, or our very own West Midlands Pension Fund workers scheme at $13bn, it’s public sector workers’ money that makes the world go round. The UK pension fund industry manages over $2tr of assets on behalf of UK domestic pensions.
To repeat, the fees from ‘investing’ the pension funds assets amount to $150bn, every year. The OECD annual world pensions research indicates that fees charged to pension funds are averaging 0.5% of the entire fund each year. While non-OECD countries tend to have the higher end of fees, often well over 0.5% and sometimes 1%, it is not unusual in this country to find pension fund fees over 0.5% of the entire assets in investment every year.
UK Local Government Pension schemes average about 0.2%, but some are as high as 0.8%.
As mentioned here before, these payments are rarely linked to the actual performance of the fund. They get paid at about the same rate every year pretty much regardless, because they are assessed and paid on the basis of comparable performance of other funds!
As long as everyone is doing badly in one year, everyone gets paid the same old massive fee.
I have proposed regularly that the $2tr of UK Pension assets under management of the UK pension fund industry be subject to Management and Investment of Funds Regulations to ensure that much more is invested in the UK, especially in UK businesses, housing and infrastructure.
Just 5% of the assets under management being invested in UK business growth, infrastructure and housing could mean an £62bn investment in Britain: now. I’m afraid that investment in Britain’s infrastructure, UK businesses and housing has not been a dominant feature of the recent investment strategies of UK pension funds.
However, in the short-term I propose that we cap the administration and investment fees paid (especially by public sector pension funds) to a level that most people paying into those funds would regard as acceptable to manage their money.
The balance between what is currently paid and what would be paid under a cap should, as an experiment, be immediately ploughed by the funds into UK regional investment: in equity shares in UK businesses in the regions, in UK infrastructure and in UK housebuilding. This would be the shot in the arm regional economies need now and without borrowing a penny.
I would propose a very modest cap at 0.05% of the assets in management each year, most especially in public sector pension funds. I would also make them entirely performance-led: if funds perform badly fees should be paid on a sliding scale downwards based on performance, down to 0% if necessary.
If, on a modest estimate, 0.25% of UK pension fund assets are currently paid out in fees, there could be as much as $5bn paid each year just in investment management fees (I suspect it is higher). If we cap at 0.05%, then immediately available for UK regional investment would be $4bn every year: a feebate.
This is rebalancing. Instead of money invested in high finance, we can put it into real investment in our UK regions, creating jobs and growth.
Why do I suggest 0.05%? Because that is how much some of the biggest and most successful pension funds in the world manage to charge for investment management. These funds, in terms of performance, do very well (and in some cases much better) than those being charged ten times as much.
South Yorkshire local government pension scheme manages to charge 0.05%. The canniest, though, is the West Yorkshire pension Fund scheme. It is the 246th biggest pension fund in the world. It is a very successfully run scheme.
Last Year it paid £1,733,000 in investment management fees for assets under management of £8.63bn. That’s actually 0.02%. So capping investment fees at 0.05% is actually very generous.
There can be no complaints that the funds’ assets are under threat; the same assets would be under management and in the same way, it’s just that they’ll be managed more cheaply.
If West Yorkshire can do it, so can the rest of the UK Pension fund industry, as far as I’m concerned. West Yorkshire could manage the lot, I suspect.
The pension funds themselves can manage the feebate to invest it in regional UK growth bonds, perhaps in municipal bonds of local authority consortia. They can’t lose. The money was just going into the pockets of the investment managers the world over.
If it means a rebalancing in the economy away from high finance to jobs in manufacturing, green industry, small businesses and construction, then so be it. That’s exactly what we want. Actually, though, the real problem is not with employee or administration costs as such, it is the ‘investment management’ fees that really clock up. It’s a racket.
So, let’s get the £billions in wasted fees (charged out of the ordinary savings of pensioners) out of the pockets of investment managers. They demonstrably do nothing to deserve them. Instead let’s put the fee £billions into direct investment in our regions.
Let’s have a feebate.
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Michael Johnson, Research Fellow, Centre for Policy Studies
I agree with John’s sentiment that the industry extracts too much rent, given its generally lousy performance, but I would ask the question “why do UK pension funds invest relatively little in UK infrastructure?” They clearly do not like the risk for the return on offer. John’s solution appears to commingle two very different issues: industry remuneration and the funding of infrastructure, in the form of top-down diktat / Soviet-style central command, with politicians pulling the strings. That does not sound like a sensible solution.
I recently published a paper Put the saver first, backed by Conservative and Labour peers, which goes into great detail on the theme of fees.
Section 12.3, starting on page 150, considers fund management remuneration. I discuss the industry’s ownership structure and how performance and reward are wholly misaligned, proposing that asset managers’ fees should reflect the value added as per:
Proposal 76: Fund managers should aim to return to their investors at least 65% of their target excess return. No fees should be charged in respect of performance below the benchmark, other than a small access fee to cover the cost of the basic service being provided (primarily administration and safe custody). As you may know, Steve Webb is considering capping fees.
All that aside, I would suggest an alternative approach to cutting the industry’s remuneration, a process that could be driven by the LGPS, and it would result in improved LGPS fund performance.
The LGPS: consolidation is in the public interest
The Local Government Pension Scheme (LGPS) is a disparate collection of 101 separate funds, mostly of sub-optimal scale and delivering sub-optimal performance. Several are now so under-funded that they are beyond the point of no return. Now having to consume their assets to meet pensions in payment, such funds are in a death spiral. The inability of the LGPS to control costs is masked by the ineffective governance tripartite of employers, central and local government. Taxpayers, who will have to foot the bill resulting from the lack of accountability and clear authority, need to know not only how this has come about, but also what is going to be done. There is a two-part solution to this problem.
First, the funds should be open to independent public scrutiny. However, sourcing the primary data, the necessary pre-requisite to do this, is presently very difficult. One initiative required 199 Freedom of Information requests (mostly denied) and then (successfully) resorting to the Information Commissioner; a two-year battle. This culture of opacity must be confronted. It provides the backbone of the defence from those opposed to change, and is at odds with the today’s clamour for more transparency in respect of the financial services industry.
More specifically, each fund’s third party service costs should be in the public domain, alongside data for net and gross investment performance, and membership. This would expose the impact of costs on performance (and Council Tax bills), as well as providing a guide to future improvements in operational efficiency.
Second, the 101 funds should be consolidated into a smaller number of larger funds, say five, each with assets of some £30 billion. In time, they would become “expert clients” capable of extracting best value from the financial services industry, and enjoying the other benefits of “scaling up”, including pooled administration and procurement. “Scaling up” would enable the new funds to harness economies of scale, thereby improving their efficiency. Larger funds:
- can utilise their buying power to secure more attractive transaction pricing, win big reductions in fund managers’ annual management charges, and also rebut initial charges;
- are better placed to afford high quality in-house expertise, needed to research the complex range of available investments, including infrastructure;
- can harvest a “governance dividend”, estimated to add 0.5% and 1% to annual returns to defined benefit and defined contribution schemes, respectively. This would free up capital for investment, perhaps in additional infrastructure projects;
- can exploit co-investment opportunities (i.e. the ability to buy a share of portfolio companies without fees); and
- have greater reach across asset classes, geographies and (fixed income) asset maturities, resulting in more diversification (thereby reducing risk).
Finally, a scheme with more than 50,000 members costs £15-£30 per member to administer, compared with up to £200 for one with fewer than 1,000 members. To the extent that these benefits reduce fund costs, they help address deficits.
The unions are in favour of fund consolidation (witness their submissions to Lord Hutton’s commission), as are many councils, irrespective of political hue. Ideally, local government bodies working with the unions will themselves set this in train, accompanied by a statement of support from the Coalition (which would help ease the current negotiations). In the meantime, DCLG could overhaul the LGPS’s governance framework. Such initiatives would also provide some comfort to Council Tax payers, and Income Tax payers, the ultimate underwriters of the deficits in the LGPS.
