EDINBURGH - The average total cost for running a large U.K. pension fund is only 12 basis points, according to preliminary results from a survey by The WM Co., Edinburgh.
The survey, the first of its kind performed in Britain, further reveals it is far cheaper to operate an internally managed fund, at an average cost of eight basis points, than one that is externally managed, an average 18 basis points.
However, some observers believe these figures are far too low, especially when compared with average costs for running U.S. pension funds. WM officials estimate the cost of operating a U.S. pension fund at 50 basis points - four times the comparable level for a British fund.
While it is widely acknowledged that costs - particularly money management fees - are cheaper in Britain than in the United States, some experts believe the WM data underestimate true costs. Use of hidden charges that do not show up in the books and incomplete allocation of overhead expenses would cause costs to be understated.
Other experts, however, said large British pension funds have sufficient clout to obtain sharply lower money management fees.
First U.K. effort
Interest in measuring pension fund costs is rising, particularly in North America, Britain and the Netherlands, consultants said. Toronto-based consultant Keith P. Ambachtsheer has been measuring costs for five years for U.S. and Canadian funds, and has just started offering the service to Dutch pension funds.
WM's survey represents the first stab at measuring U.K. pension costs. Responses were received from 58 pension fund clients, each of which has at least (British pounds)500 million ($775 million) in assets. The three most costly and the three least expensive funds were lopped off, resulting in a universe of 52 clients with total pension assets of (British pounds)110 billion ($171 billion).
Of the 52 funds, 18 were primarily internally managed, with total assets of (British pounds)66 billion; 34 were primarily externally managed, with total assets of (British pounds)44 billion.
The most important factor in determining cost is the "management method" - such as whether the fund uses a core/satellite or balanced approach, and how many managers are used, said John Williams, client director for WM.
Also significant is the size of the fund, although that is less reliable as a predictor of costs. Larger funds generally were cheaper to run because of their economies of scale, but some funds in the smaller end of the universe had lower costs, while some megafunds proved to be expensive providers.
What stunned WM executives and outsiders, were the low costs associated with running a large U.K. pension fund. For both internally managed and externally managed funds, investment management, custody and related fees comprised about 70% of costs.
Even in the worst-case example, where it cost 40 basis points to manage the fund, the 900 basis points real return earned by the average U.K. pension fund during the past decade made the additional cost relatively cheap.
WM officials have yet to analyze whether performance was correlated with higher costs, whether internally or externally managed funds got more bang for their buck, or whether the level of indexation aided cost efficiency. Additional analyses will be performed during coming months.
In seeking data, WM officials asked U.K. pension executives to supply data on: securities management and custody, which often are bundled together; property management; investment support, such as technology; administration; actuarial work on investment issues, such as manager searches; legal and audit fees; and overhead expenses, such as office space and staff salaries. Benefit administration costs were not included.
However, WM gathered data only where companies had allocated costs to the pension fund. If a company, for example, failed to allocate the salary of a financial executive spending a portion of his time on the pension fund, the survey would not have picked up the cost. In addition, average costs were not weighted by size of fund. That way, a few large internally managed funds with very low cost structures did not skew the data.
WM data questioned
Still, some experts questioned the low figures cited by the WM study. One former U.K. pension executive, who declined to be named, said an average 18 basis point cost is "ridiculous." He suggested there is a downward bias in the figures, because staff assigned to completing surveys tend to supply only the most readily available data.
Susan Douse, a senior consultant at Watson Wyatt Worldwide, Reigate, said large funds can negotiate substantial fee breaks. While the figures seemed reasonable to her, she also questioned whether all costs were being picked up.
In particular, hidden or indirect fees still account for a significant cost, she said. Hidden fees, which include such things as cash management costs, use of internal pools, and bloated and soft commissions, affect the value of the portfolio but don't show up in the books, experts said.
But Colin Price, investment services manager for Shell Pensions Investments, London, said WM's data were "in line with our findings and our own experience."
Robert Ross, director of consulting for Frank Russell Co., London, said a (British pounds)5 billion externally managed pension fund could obtain money management fees below 10 basis points for balanced portfolios, while internally managed funds could keep non-property-related investment management costs to around five or six basis points. He said, however, that hidden costs are substantial.
Data from Greenwich Associates, Greenwich, Conn., substantiates that view, and further suggests costs for U.K. pension funds are far higher than WM's survey suggests. A Greenwich survey found British pension funds with more than (British pounds)1 billion in assets paid average money management fees of 18.2 basis points last year, plus an additional 4.2 basis points in hidden charges, creating a total cost of 22.4 basis points.
U.K. funds with (British pounds)501 million to (British pounds)1 billion in assets paid an average 20 basis points plus 7.4 basis points in hidden costs, totaling 27.4 basis points. Both figures exclude additional costs of operating a pension fund. Applying WM's ratio that securities management and custody cost about 70% of total fund costs, the Greenwich data imply U.K. funds with more than (British pounds)500 million in assets paid an average of 32 to 39 basis points.
By comparison, Greenwich found U.S. corporate pension funds with more than $1 billion in assets paid an average of 40 basis points last year to outside managers alone, excluding custody and other fund costs. (U.S. public funds exceeding $1 billion paid only 27.3 basis points in money management fees.)
In Canada, where fees are lower, Greenwich said all Canadian plans with more than C$500 million in assets paid an average of 27.1 basis points.
Cost measurement studies conducted by Cost Effectiveness Measurement Inc., a Toronto-based firm run by Mr. Ambachtsheer, also suggest costs of managing a pension fund are significantly higher than the WM data indicate. He also asserts funds cannot be compared directly, and that funds must be broken into their constituent parts, to take into account factors such as liability structure and risk tolerance.
For each factor of 10, a fund saves roughly 20 basis points as a rule of thumb, he said. Thus, it cost 20 basis points less to manage a $10 billion fund than a $1 billion fund, he said. It is more expensive to manage equities, and even more for alternative asset classes, he said.
A $10 billion U.S. pension fund with an asset mix of 55% stocks, 40% bonds and 5% alternative investments, the cost would have been 24 basis points in 1994. That compares with 43 basis points for a $1 billion fund with the same asset mix. For large Canadian funds with an asset mix of 50% stocks, 45% bonds and cash and 5% alternatives, pension fund costs would be about 11 basis points for a C$10 billion fund and 30 basis points for a C$1 billion fund.