Understanding the Fees Charged Within Fiduciary Management
January 2014
Aon Hewitt
Delegated Consulting Services
Overview . . . 2
What are the fee components? . . . 3
Key definitions . . . 3
Fee approaches: bundled vs unbundled . . . 5
Would you expect fiduciary fees to be more expensive? . . . 5
Are fiduciary fees actually more expensive? . . . 6
Where fees are higher, do the benefits outweigh? . . . 6
Fees may be lower with a fiduciary approach . . . 6
Comparing fiduciary provider fees . . . 7
Conclusion . . . 8
Table of contents
Overview
Fee structures and the level of fees paid for fiduciary management can vary significantly between providers and depending on the solution being offered. This makes comparing fiduciary fees extremely difficult, particularly where providers are unable to provide detailed breakdowns of fees (for example, due to confidential fee discounts that have been negotiated).
In this paper we look at the different elements of the fees charged within fiduciary management, the structure of them and how trustees and sponsors can go about comparing providers’ fees. We also look to address the highly topical question, ‘Are fiduciary fees actually more expensive than a traditional approach?
Sion Cole
Partner and Head of Client Solutions Delegated Consulting Services +44 (0)207 086 9432 sion.cole.2@aonhewitt.com Follow me on twitter @PensionsSion
Understanding the fees charged within fiduciary management
What are the fee components?
When appointing a fiduciary manager, it is important to understand not only the overall fee being charged but also the different components / elements of this, how exactly it is charged and whether there are any other costs to take into consideration.
The fees charged within fiduciary management, and other costs / fees that need to be looked at, can be broken down into four component parts and summarised as follows;
1. Fiduciary management (provider) fees
2. Underlying manager fees (ie, fees paid to external managers and any internal asset management fees, including any fee savings on external managers) 3. Investment consultancy fees (if any)
4. Other fees: Administration costs (usually taken directly from the underlying funds), custodian fees (although not in all cases), legal review fees, transition management fees The two approaches to how these fees are charged (bundled or unbundled) are detailed in the next section of this paper. Firstly we detail what each of the fee components includes.
When appointing a fiduciary manager, it is important to understand not only the overall fee being charged but also the different components / elements of this, how exactly it is charged and whether there are any other costs to take into consideration.
Key definitions
• Full fiduciary management: trustees set the overall strategy (including the long-term risk and return objectives) and then delegate all investment decisions and day-to-day running of the portfolio to their fiduciary manager.
• Partial fiduciary management: trustees delegate all investment decisions for only a specific section of their portfolio (eg, the alternatives or liability hedging assets). Trustees maintain the decision making on the rest of the portfolio.
• Strategic de-risking mandate: the trustees ask the fiduciary manager to implement the de-risking triggers (typically funding level driven) that form part of the trustees’ ongoing strategic benchmark.
• Fully delegated: parameters agreed at outset with client, provider then makes all day-to-day investment decisions.
• Directive: which requires ongoing client input before the provider implements.
1. Fiduciary management fees
This fee covers the services provided by the fiduciary manager.
These services can broadly be broken down according to:
the different ‘flavours’ of fiduciary management (full, partial or strategic de-risking) and how the fiduciary manager implements advice (fully delegated or directive).
Fiduciary providers’ fees tend to be higher when there is greater tailoring of the solution.
The key aspects / services included within full fiduciary that will impact the fees charged are likely to include: determination of the growth / matching split, deciding which asset classes to invest in within the parameters agreed, incorporation of tactical asset allocation, design and implementation of a flight plan (including monitoring of assets and liabilities to checking funding levels), where risk is taken, risk modelling, risk monitoring, ongoing manager selection / de-selection and monitoring, and client reporting.
Other (Custody / admin /
legal)
Underlying manager
fees
Investment consultancy
fees
Fiduciary management
fees
The fiduciary providers will be responsible for the investment portfolio and deal with the day-to-day investment decisions of the scheme’s assets. The number of services provided through a fiduciary mandate can outnumber those taken by the scheme prior to implementing the solution.
Fiduciary providers’ fees tend to be higher when there is greater tailoring of the solution. They often have standard fees but can sometimes be flexible around this; the proportion and level of base fee / performance fee can be adjusted or clients may wish to look at hurdles or caps on performance fees.
How are the fees charged?
This element of the fee can be in the form of a base fee (which can be a fixed amount in £ or, more usually, charged as a percentage of assets invested), or a base fee (as stated previously) plus a performance fee; where the performance fee is driven by some form of metric (often related to funding level which is defined and agreed with each specific scheme). For example, 30bps (0.30%) base fee plus 15% performance fee.
The performance fee can be on any outperformance above the liability benchmark or with a hurdle rate of, say, liabilities +1%
p.a. The structure of the performance fee is important as it can be used to help align the interests of the client and the provider. For example, a form of spreading mechanism could be used which encourages steady performance and alignment of interests, where the performance fee vests over three years, say.
The structure of the performance fee is important as it can be used to help align the interests of the client and the provider
2. Underlying manager fees
The fiduciary manager will select and invest in a number of funds on behalf of their clients. These may be internally- (subsidiary of the fiduciary manager) or externally- (completely independent of the fiduciary manager) managed funds. Base fees are paid to the underlying managers (and potentially a performance fee), and this is paid out of the assets held / managed.
Underlying manager fees vary significantly depending on the solution. This is predominantly dictated by the growth / matching split, asset classes invested in, asset allocation and the actual fund manager(s) selected. For example, a 75% growth-seeking allocation targeting high long-term returns alongside a highly-leveraged liability matching component will command higher fees than a 50% growth-seeking allocation targeting more modest returns combined with a more basic bond portfolio for the matching component.
Growth assets are generally more expensive than
matching assets and actively managed funds are more expensive than passively managed funds. This means that any change in growth / matching split and underlying managers will likely impact fees.
Underlying manager fees should be independent of the fee paid to the fiduciary manager for their services and there should be no incentive for the fiduciary manager to pick anything other than those managers that are in the best position to deliver outperformance (net of fees). The fiduciary manager should also use their scale to negotiate fee discounts on behalf of their clients and ideally pass 100% of these through to the clients (ensuring transparency).
3. Investment consultancy fees
When a pension scheme uses a fiduciary provider, the trustees will still need to receive advice from their investment consultant on the investment objective for their pension scheme, the timescale to achieve that objective and the desired de-risking framework (flight plan) to get there. In addition, the scheme’s investment consultant will help with regulatory requirements, such as the signing of the SIP advice letter or a Section 36 letter.
How are the fees charged?
These fees are often included as part of the fiduciary manager fee. Where they aren’t, they are either charged as part of a fixed fee arrangement where all services are defined and included, or each service is charged separately. This is on a fixed fee basis (for example, project fees that are typically agreed in advance), on a time and materials basis, or a combination of fixed and time and materials.
4. Other fees
There are a number of potential additional fees that should be checked and taken into consideration. These include one-off fees / costs; transition fees (if a transition manager is used they will charge a management fee to transition assets more efficiently, plus there are the actual restructuring / transfer costs in addition to this); legal fees (to review any Investment Management Agreements (IMAs) or custody agreements). Ongoing fees / costs include custody and admin costs (custodians can hold assets on clients’ behalf and will charge a fee for this, known as a ‘safekeeping fee’. This is calculated as a percentage of the total assets held, similar to management fees, although the fee will also vary depending on which country the assets are held in).
It is also important to consider other implicit costs / fee elements such as sponsor contributions. If a scheme is better funded and a flight plan has meant greater certainty, there is less need for the sponsoring employer to fund additional contributions to reduce the funding gap (thereby reducing any impact on the balance sheet).
Fee approaches:
bundled vs unbundled
The fee approach a fiduciary provider adopts, and offers to their clients, very often reflects the heritage of the provider. There are two approaches typically used when charging fiduciary fees; ‘bundled’ and ‘unbundled’.
Providers borne out of asset management houses will typically bundle their fees with those of the underlying fund managers being appointed — giving certainty of overall costs but not passing on fee savings or reflecting the cost of the underlying solution. A bundled fee approach provides one overall fee for fiduciary management. The costs of individual services are not quantified and the fiduciary manager will bear the
underlying investment costs from the fund managers used.
This approach provides certainty regarding the costs of your fiduciary solution.
A bundled fee approach provides one overall fee for fiduciary management.
However, the lack of clarity of where costs are incurred could lead to investors paying a higher charge than necessary through a bundled approach. For example, if their portfolio incurs very little costs from asset management (due to passive assets having lower underlying fund manager fees), or the client does not require most of the fiduciary services on offer. The fees charged also do not reduce over time as part of the flight plan and de-risking programme. Paying a standard ‘one size fits all’ fee can leave you exposed to costs accumulated from services you actually don’t need or want.
In contrast, providers which have emerged from consultants will typically have an unbundled approach, where they set their fees separately from the underlying managers, with fund manager fee savings flowing through directly to clients. The cost of the underlying solution is clearly shown — often a benefit to flight plan clients as the solution is expected to become cheaper over time as assets move from growth to matching.
An unbundled fee approach separates all underlying fees in a portfolio and will outline a range of fiduciary fees based on what services are required. This approach gives much greater clarity on where costs are incurred. This also gives fiduciary providers the ability to show clients where they have made fee savings, for example through
asset management fee negotiations. However, using an unbundled fee approach could be equally costly. A small portfolio consisting of active and alternative assets will pay a significant asset management fee. As is usually the case with such assets, the asset management fee may be on a tiered basis and hence will reduce with larger investments;
there is therefore the potential to make savings by pooling assets together through a fiduciary manager and to use a bundled fee. Unbundled fees will vary through time as the portfolio evolves, for example they often reduce over time where a flight plan is in place and the scheme progresses through this. Whilst an unbundled approach offers transparency, there is no certainty on the total cost (as per a bundled approach).
An unbundled fee approach separates all underlying fees in a portfolio and will outline a range of fiduciary fees based on what services are required.
It is important that trustees decide which approach they are most comfortable with and understand the pros and cons of each. There is not necessarily a right or wrong answer and this is very much a client-specific decision, as with most elements of fiduciary management.
Would you expect fiduciary fees to be more expensive?
If you move from a largely passive to active management approach, would you expect the fees and costs involved to increase? Most people would, as the skills, resources and investment processes needed to undertake active management are greater and more complex than those involved with passive management. That is not to say that passive management is the wrong option, simply that active portfolios tend to have higher fees but in return offer the potential for better returns, outperforming the index (or passive funds). For example, a passive equity manager may charge a management fee of 10bps (0.1%), whereas an active equity fund manager will charge a much higher management fee of around 60-80bps (0.6%
to 0.8%).
Similarly, you would expect a move from, say, a portfolio of active equity, bonds and (some) property to a more complex diversified growth fund (with tactical asset allocation and currency hedging, for example, as well as a more diversified portfolio) to be more expensive.
So would you expect to pay more if you moved to a fiduciary approach? Most people tend to assume that fiduciary fees will be more expensive than what they are currently paying due to all the elements / services included and the benefits on offer. However, are they actually more expensive in practice?
Are fiduciary fees actually more expensive?
Using a fiduciary service is often considered a more expensive option to a scheme’s current approach;
however is it actually more expensive in practice?
The answer to this is both yes and no. It is very much dependent on your current starting point (ie, what investment portfolio and services you have in place) and where you are looking to get to (ie, what your aim is and what you want to get from your fiduciary manager).
As mentioned earlier, an actively-managed equity portfolio is more expensive than a passive equity portfolio. This is not to say that you should therefore choose passive - both portfolios cannot be compared on a fee-only basis. The active portfolio will have higher fees because the investment process is much more complex and requires more skill and resources. The fund would also aim to outperform an index, adding more value to your investment and therefore outweighing the higher fee charged. As an investor, you are paying more for a more complex service and in return you hope your investment will benefit. The same methodology should be used when considering a fiduciary manager - what are you getting for your money?
One of the primary objectives of fiduciary management is for the provider to take responsibility of your
scheme’s investment portfolio and deal with the day-to- day decisions, as well as managing medium-term asset allocation, portfolio risk and liability hedging. This frees up trustees’ time to focus on the higher level and more strategic decisions of the pension scheme. It is therefore important to consider the time saving that this service provides and how much value can be put on that.
Where fees are higher, do the benefits outweigh?
With this in mind, we can now consider whether fiduciary providers are more expensive. Where a scheme’s current portfolio and investment strategy is highly focused on passive management, with a basic portfolio of equities and bonds, and no liability matching, then a move to fiduciary management will mean an increase in the overall fees the scheme would pay. However, if the scheme were to try and incorporate all the elements themselves (involving time, resources and expertise to review, monitor and implement such a strategy) then the costs could be even greater. The extra costs should be weighed up against the potential benefits of fiduciary management. Ultimately, if your risk / return profile is enhanced and the likelihood of your scheme reaching fully funded increased, then we believe cost should be less of a driving factor in any decision.
Another example would be where the trustees of a scheme are satisfied with the current strategy employed and no active decisions have been made on the scheme for some time (ie, no asset allocation or manager changes and limited investment advice sought). In this instance, moving to a fiduciary approach would increase the overall fees. However, in this case, by using a fiduciary manager the scheme would benefit from active day- today management of the assets without increasing the governance requirements of the trustees. In addition, greater diversification of the growth assets and a better matching portfolio would reduce the risk and volatility associated with the scheme, thereby ensuring an increased certainty of reaching the scheme’s long-term target.
Fees may be lower with a fiduciary approach
There are some instances where moving to a fiduciary management approach can actually be cheaper, without even considering any added value it offers. For example, a scheme which has an existing portfolio comprised of a high number of active equity and hedge fund managers, with complex liability hedging arrangements, would benefit from fiduciary management. Appointing a fiduciary provider would improve their governance structure (one IMA, no manager selection and review costs etc) and the fiduciary manager would be able to negotiate better fees.
The fee savings generated by fiduciary managers, due to using collective bargaining agreements, can outweigh any additional fiduciary management charges.
There are some instances where moving to a fiduciary management approach can actually be cheaper, without even considering any added value it offers.
Another example of when a fiduciary approach would be cheaper is when the trustees are looking to implement a flight plan approach using both funding level and yield triggers. If the scheme does not have a fiduciary manager in place, this could result in a considerable time burden on the trustees and significant cost resulting from the trustees and their advisors monitoring the trigger levels set. The scheme could also miss out on opportunities to lock in funding level gains if they are not able to react quickly enough to market conditions, which may impact on the level of employer contributions required. However, if a fiduciary manager is implementing a scheme’s flight plan as part of their service, the plan will have been agreed at the outset with minimal ongoing involvement from the trustees. The overall cost can therefore be less but with the same (if not better) benefits on offer.
As discussed, while fiduciary fees can be higher, they can also be lower and this really depends on a number of factors. The most important aspect is to assess if what is being offered and whether the added value / benefits are worth the fees being charged. The same process applies when looking at different fiduciary providers and the fees they charge - it is important to compare like-for-like and assess any differences in fees and the value that offers your individual scheme.
While fiduciary fees can be higher, they can also be lower and this really depends on a number of factors. The most important aspect is to assess if what is being offered and whether the added value / benefits are worth the fees being charged.
Comparing fiduciary provider fees
It is clear that the fees charged for fiduciary management services can be complex. They can also differ significantly between providers, and within providers depending on the solution offered, and this therefore makes comparing fiduciary provider fees difficult. The most important thing is to try to ensure that when comparing fees, you are comparing like-for-like. Where the offerings do differ it is important to understand how they differ, the impact they have on fees, whether you need those additional elements and if you are willing to pay for those extras.
For example, this is exactly the same as when deciding which house to buy. There are some instances where two houses can look very similar from the outside but the prices can differ significantly. You ask yourself why one costs 20%
more than the other. When you enter the houses and start looking around and asking the estate agents questions you notice there are vast differences. One may have an additional bedroom, the master bedroom has an en-suite and there is a study built above the garage. You have to ask yourself if these extra rooms are worth paying more for and, if so, how much more? Do you need the extra bedroom or would it be surplus to your requirements and therefore an unnecessary expense?
The most important thing is to try to ensure that when comparing fees, you are comparing like-for- like. Where the offerings do differ it is important to understand how they differ, the impact they have on fees, whether you need those additional elements and if you are willing to pay for those extras.
For fiduciary management, there are three key elements that make up the solution / offering and that have an impact on the fees charged; the fiduciary provider and overall solution, growth / matching split, underlying investments and instruments.
It is therefore important for trustees to look not just at the top line fee but to understand the details behind this and how the solutions differ. It is important to try and compare providers, and fees, on a like-for-like basis, as this will help you differentiate between them so that you can decide which matches your scheme’s needs and whether you are willing to pay for that level of service / solution.
1. Fiduciary provider and overall solution / service
The overall solution and service levels can differ between providers. The services that may be included were outlined earlier in the fiduciary manager fees section of this paper.
Some solutions will include flight planning within the fee quoted whereas others may charge extra for this or not be able to provide the same level of detail in their flight plan offering. For example, some will offer daily monitoring of funding levels with same day implementation when triggers are hit, whereas other solutions may take several days or even weeks to make any changes, or monitoring may not be as frequent. It is also important to understand what other elements are included within the fee, such as asset allocation views.
Fiduciary managers should be able to provide a breakdown of the services incorporated into their fiduciary fee, offering trustees the granularity to compare providers on a like-for- like basis.
2. Growth / matching split
The split of assets between growth and liability matching components will have a significant impact on fees. Typically growth portfolios have higher underlying manager fees due to the skills and resources required to generate returns for the pension scheme. In this instance, the investments required to generate the returns needed have higher fees.
So a 70:30 growth / matching split will have a higher overall fee compared to, say, a 50:50 split.
The important consideration here is the growth / matching split that your scheme will need in order to meet your investment objective and long term goals. For example, a 2 litre Audi will have a higher top speed than a 1.2 litre Audi (and be more expensive); however if you don’t need the extra speed (or in the case of a pension scheme, if you don’t need the higher growth allocation in order to generate higher returns to reduce a larger deficit) then it won’t be worth paying the extra.
3. Underlying investments and instruments
The actual underlying investments and instruments used within the portfolio can impact on the overall quality of the solution being offered as well as the fees being charged.
For example, within the growth portfolio the proportion of active versus passive funds utilised will impact on fees as well as the level of returns on offer. The asset classes invested in will also impact both of these, as is the case with hedge funds - they are more expensive than other asset classes but add an additional element of diversification and sources of return which can be extremely beneficial. Hedge funds often play a greater role in helping to achieve more aggressive investment objectives.
Similarly, the tools and instruments used can impact the fees as well as the overall solution. Using leveraged liability matching funds can release more capital to allocate to the growth component (to generate returns) while offering the same level of hedging / protection against interest rate and inflation risks. These more efficient funds tend to be more expensive, though, than some standard Liability Driven Investment (LDI) solutions.
Cheaper solutions can often be found by asking managers to exclude certain asset classes from the solution, increasing the passive management, or utilising lower cost (but less efficient) LDI tools. This is something that schemes will need to consider on a case-by-case basis. Smaller schemes in particular may be willing to opt for a less bespoke, higher beta growth portfolio in order to reduce the overall cost, whilst still achieving the returns they need.
What is most important is not ‘is one fiduciary offering more expensive than another’, but for trustees to ask what added value they are getting if it is more expensive. Trustees should evaluate managers based on their solution and the services offered.
Conclusion
There are four key components to the fees that UK pension schemes pay for fiduciary management and it is important to understand each of these, and for providers to be clear and transparent to help trustees with this.
Are fiduciary fees more expensive? In this paper we have outlined examples where fiduciary fees are more expensive and when they are actually cheaper. It ultimately depends on what your current portfolio and investment strategy look like and where you are looking to get to. Choosing to go down a fiduciary management route could be more expensive or more cost efficient, depending on a number of factors. More important than the overall fiduciary fee being quoted is the investment portfolio and strategy being adopted and the added value on offer.
Comparing fiduciary management fees can be extremely complex given the different fees charged and the way they are charged to you. By now, the picture should be clear that fiduciary providers cannot be compared on a fee-only basis. When comparing fiduciary fees, trustees / sponsors must delve into details of the services being offered as it is important to try and compare like-for-like, apples versus apples, and not focus on a fee headline.
The same overall fee may result in very different types of solution being offered by providers. As we have discussed, the different growth / matching splits and underlying investments can have a significant impact on the cost.
What is most important is not ‘is one fiduciary offering more expensive than another’, but for trustees to ask what added value they are getting if it is more expensive. Trustees should evaluate managers based on their solution and the services offered. Is it worth it? Are you willing to pay the extra? Some trustees will be happy to pay extra for some elements included within the fee; however others may request the provider to reduce the cost by, say, removing some of the more expensive asset classes or including some passive underlying funds or taking away elements of the offering that are surplus to their scheme’s requirements.
After all, the whole concept of fiduciary management is to delegate the investment decisions and day-to-day running of the portfolio. Therefore by understanding all elements of fiduciary fees and being clear what services you require, it is much easier to select the right solution for your portfolio.
All schemes are unique and therefore there is no one solution that fits all.
Contact
Sion Cole
Partner and Head of Client Solutions Delegated Consulting Services
+44 (0)207 086 9432 sion.cole.2@aonhewitt.com Follow me on twitter
@PensionsSion
About Delegated Consulting Services
Aon Hewitt’s fiduciary offering (Delegated Consulting Services) is focused on helping trustees and sponsors achieve better security for their scheme members. We do this through helping you meet your unique long term objectives and, importantly, through improving your scheme’s funding level. What makes us different?
Only we ask the best questions and then really listen to exactly what our clients tell us. By working in partnership in this way we can then create a truly bespoke solution that is designed to meet your unique requirements. We don’t just say bespoke, we live by it.
Aon Hewitt currently holds fiduciary manager of the year awards from three of the industry’s leading publications; Professional Pensions (2015), Pensions Age (2015) and the FT (2014). Our ability to create truly bespoke solutions has been cited as part of these award wins and is one of the reasons why our clients vary significantly in size and how we work with them. Examples of some of the solutions we can offer clients include full fiduciary with bespoke growth and liability matching portfolios and daily monitoring of triggers. We also offer single solutions (partial fiduciary mandates) such as hedge funds, alternatives mandates and flight planning with dynamic de-risking programme.
Aon Hewitt empowers organisations and individuals to secure a better future through innovative talent, retirement and health solutions. We advise, design and execute a wide range of solutions that enable clients to cultivate talent to drive organisational and personal performance and growth, navigate risk while providing new levels of financial security, and redefine health solutions for greater choice, affordability and wellness. Aon Hewitt is a global leader in human resource
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Working in partnership with our clients
At Aon Hewitt we believe in working closely with our clients from the very outset to understand the challenges they face and their individual needs. Working in partnership with the trustees and sponsor, we create a bespoke solution to help address these issues and help them to meet their long term goals. No two clients of ours are the same and each have their own bespoke liability benchmarks, reflecting our truly tailored delegated offering.
To talk to us about any of the points we have raised in this paper or to find out more information about our delegated offering, please do not hesitate to contact your Aon Hewitt Consultant or Sion Cole, Partner & Head of Client Solutions, Delegated Consulting Services, on +44 (0)207 086 9432 or at sion.cole.2@aonhewitt.com.
aonhewitt.com/delegatedconsulting
About Aon
Aon plc (NYSE:AON) is a leading global provider of risk management, insurance brokerage and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 69,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative risk and people solutions. For further information on our capabilities and to learn how we empower results for clients, please visit:
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