While asset management charges are increasingly under the microscope, data costs – which continue to rise across the industry – seem to be attracting little scrutiny.
Do you know how much you are being charged in asset management fees? And do you know exactly what those fees include? Few, it seems, do.
Pressure is growing to increase fee transparency across the industry. Yet this needs to be much more granular if asset owners and end investors are to truly understand everything they are being charged for, and how to minimize those costs.
“My advice to people is always read the small print, because it may be that costs you expect the asset manager to bear are being borne by you,” says Dr Christopher Sier, Managing Director at Stonefish Consulting, and author of a new Financial Services Consumer Panel study on cost transparency in the UK pension market. “If it’s a cost that draws down from your pension fund then it should be explicit. If they are spending your money on your behalf, you need to know how much they are spending.”
Calls for greater transparency
Investors agree, according to a new CFA Institute global survey. It found full disclosure of fees and other costs is the most important attribute both retail investors (cited by 80% of respondents) and institutional investors (72%) want when working with an investment firm – even ranking above returns. But there is widespread dissatisfaction. Less than half of retail and institutional investors say they are satisfied with the fee transparency they receive.
To tackle the issue, the UK’s Investment Association is reportedly discussing with the Financial Conduct Authority (FCA) how the fund management industry can improve the disclosure of charges and transaction costs. The trade body intends to consult on its draft disclosure code for pension fund charges towards the end of the year.
“What we want from an industry perspective is to proactively join the UK and EU regulatory requirements together as far as we can,” Jonathan Lipkin, the Investment Association’s director of policy, was quoted as saying. “We can see a way to build an underlying system, a common template, that will provide data tailored in a way that is suitable to both retail and institutional investors.”
Regulators take aim
The Central Bank of Ireland is also set to investigate the fees charged by Irish-domiciled investment funds during 2016. According to a FT article, the regulator’s initial focus will be on total expense ratios (TER), which usually comprise the manager’s annual charge plus other services paid for by the fund, such as custodian and auditor fees.
Yet while there is a good understanding of the headline fees that comprise TERs, the amount that hidden fees, in particular transaction costs, impact total returns is “either completely ignored or misunderstood by many,” says Gina Miller, founding partner at wealth manager SCM Private, who leads the True & Fair Campaign, which lobbies for fee transparency. “There is little transparency in pension funds, characterized by numerous layers of fees which are rarely added up and even more rarely converted into pounds from percentages. Transparency will finally occur once new EU legislation regarding MiFID II and PRIIPs forces honesty into the UK fund management industry.”
The European Supervisory Authorities’ draft proposals on PRIIPs Key Information Documents lays out what fund costs should be included in the documents and how they should be disclosed to retail investors. The paper points to both one off and recurring costs, and says the disclosed amount should include all types of cost borne by the fund, “whether they represent expenses necessarily incurred in its operation, or the remuneration of any party connected with it or providing services to it. These costs include transaction costs.” The rules are due to take effect on December 31, 2016.
The list of costs the authorities want to see included is extensive. Yet while the consultation paper does mention the need for accurate pricing of securities instruments, it does not stipulate the need to provide transparency into the related data costs incurred in the process.
UK pension cap
For its part, the UK Government introduced new rules in April 2015 to cap product fees on default auto-enrolment pensions at 0.75% of funds under management, in a bid to curb costs and make charges more transparent for workplace pension schemes.
A Department for Work and Pensions (DWP) spokesperson noted the cap “applies to all member-borne deductions, excluding transaction costs (the costs incurred as a result of buying, selling, lending and borrowing investments). This means things like scheme administration, communication and governance costs are also included in the cap – not just asset management fees.”
For occupational pension schemes, trustees are responsible for assessing the costs and charges, and reporting compliance with the charge cap. Independent Governance Committees (IGCs) are tasked with assessing costs and charges in respect of workplace personal pension schemes, with scheme providers responsible for reporting compliance.
An FCA spokesperson noted the regulator’s rules don’t require asset managers to publish an in-depth list of exactly what makes up a fee, but that asset managers must abide by COBs 11.6, and fees must be communicated fairly and transparently. Meanwhile, under the April 2015 rule, governance bodies are required “to look at charges and how they are made up.”
Adding transaction costs
“This is one of the great scandals, as revealed by successive OFT [Office of Fair Trading] and DWP investigations, namely that even experienced investors cannot calculate the total fees,” says Ms Miller. “At the moment, for many pension pots all the investor sees is the headline annual management fee, rather than a long list of administration related costs or transaction related costs. A recent DWP study found that these hidden transaction costs when fund managers deal – e.g. stamp duty, broker commissions or spreads – can add another 0.75%+ per annum to overall costs.”
The Government is considering whether to include transaction costs in the cap from 2017 onwards. To this end, the FCA and DWP have published a joint Call for Evidence to explore, inter alia:
- What costs should be included in the transaction cost reporting.
- How such costs should be captured and reported.
- Whether information about other factors that impact on investment return should also be provided.
The Call for Evidence splits transaction costs into explicit costs (e.g. broker commissions, custodian fees, stamp duty taxes) and implicit costs (such as bid-ask spreads and market impact). Exactly what should be included in the transaction costs is to be defined later.
What isn’t on the agenda is the data costs – including the cost of index and benchmark data – that firms incur as part of their investment activities.
Practices vary, but in the main data costs are normally borne by the managers, “as they are effectively already reflected in the management or administration fees,” notes Ms Miller. “[I]t is our view that unless the client is paying separately for the cost of data, it should not be required to be disclosed and added together with the other costs and charges.” Dr Sier agrees. Where asset managers absorb data costs as an expense on their P&L, it becomes a part of the management and performance fee they derive, and is not charged separately to the fund. In that case, says Dr Sier, “the asset manager can justifiably avoid divulging the cost of data.”
In other cases though, asset managers will pass on the data costs they incur to their pension fund and institutional clients, explains Dr Sier, “particularly around the valuation of OTC derivatives and the collateral that sits around those.” In situations where there is a drawdown on the value of the fund “we should know exactly what those additional costs are. And if the data is being charged separately to the management fee I want to know it.”
Whenever asset managers bear responsibility for incurring but not paying for data there is also a potential agent/principal problem, “because sometimes they buy more data than they need,” argues Dr Sier.
Rising data costs
Furthermore, the data cost burden is growing, as industry participants leverage increasing volumes of diverse and often complex benchmark and reference data from multiple sources.
Part of the issue is that expensive customized benchmarks and blended indices are becoming ever more commonplace (e.g. approximately two-thirds of the datasets that RIMES manages on behalf of clients now have an element of customization). This reflects the trend among investors to develop more complex investment objectives and constraints, as well as the increasing use of such benchmarks and indices by investment managers with specialist strategies.
The diverse range of functions that use benchmark and reference data for different purposes within each asset manager further adds to the complexity. For instance, the third RIMES Buy-Side Survey found data consumption is expanding beyond core performance and data management teams, with 80% of risk departments and 63% of compliance departments now regularly using reference and benchmark data (up from 59% and 47% respectively in 2014). As the data flows around firms become more varied in the face of shifting client and regulatory demands, calculating the total cost of data becomes more challenging.
Inefficient data infrastructures and processes compound the cost pressures. Firms frequently subscribe to redundant vendor data feeds, and must devote significant in-house resources to data collection, validation, remediation, reconciliation, distribution and maintenance.
While sourcing independent data is an important consideration for certain functions, notes Dr Sier, “across a large asset manager the same data may well be procured in a number of different siloes. So you might find they’re paying for the same thing two or three times, possibly in different ways.”
But unless there is a clear understanding of and transparency into those data-associated costs and inefficiencies, there will be insufficient pressure to tackle them. This means:
- Pension trustees need to become more knowledgeable about any data fees the funds are being charged back directly or indirectly, so they can exert proper pressure to ensure fees are minimized and the funds are run efficiently.
- Pension funds need greater clarity into the data costs they are being charged so they can fulfil their responsibilities, and where appropriate negotiate better fees with asset managers and pension consultants.
- Asset managers must take a hard look at all their fees, including the total cost of data, if they are to satisfy emerging regulatory and client demands, and still maintain a healthy margin. This need will become even more pronounced in the wake of MiFID II unbundling of commission and research charges, should asset managers opt to generate more research in-house and thus have to buy additional data to support that.
Ultimately, greater transparency into asset management costs and quality will enhance organizational efficiency and help foster credibility among end investors. That can only be in the industry’s long-term interests. But to get a true and fair perspective of the total cost picture, data charges also need to be explicitly included.
How much insight do investors have into the data fees their asset managers incur, and how those are charged back to them? Do asset managers have a detailed understanding of the data costs they accrue? Why not get in touch, or complete this short survey to describe your experiences. We would love to hear your thoughts and work with you to effect positive change.