“There’s opportunity in complexity”

state street

This, believe it or not, is the new strap-line for State Street Global Adviser’s  push into the UK DC market with their target dated funds which are – it seems – reassuringly complex.

To boot

state street

There are two ways of explaining this. Either you tell your client that this is far too hard for mere mortals like him, lifting you into the class of investment super-hero, or you try to explain the complexities behind the various weightings of these five asset classes and the logic behind the changing asset allocation.

Either way – good luck.


Opportunity in complexity

It is a fundamental tenet of investment marketing that value is created by making a simple subject hard. Investing in a bundle of high yielding shares and well-selected bonds to provide a stable income in the future has the virtue of being simple but doesn’t feed a lot of mouths.

Better to have teams of analysts researching the optimum asset allocation within the Dynamically Managed Diversified Fund and other teams working out how to rebalance away from this complex asset allocation as one passes to and through retirement.

And that’s before you explain the underlying assets into which these five separate funds invest (if there is physical investment at all that is). This is at the far extreme of “hard” and I really can’t understand why things need to be this difficult.


Nothing wrong with the concept

I like target date funds because they reduce the risk of cock ups in the buying and selling of assets during the lifestyle process. I accept that the investment strategy you apply when you have no need to draw on your fund can be more aggressive than when you are relying on your fund for income. This is especially so because new cash received from your monthly contributions benefits from “pounds cost averaging”.

But what about the execution

But what I liked about target date funds seems to have been lost here. The simplicity of the concept of saving up a big fat pot and then spending it , seems to have been lost.

The State Street product, like many target dated strategies I’m asked to look at, just seems too clever for its own good. And what’s more, I’m not inclined to give State Street the benefit of the doubt when it comes to operating such a complex arrangement.

Long-standing readers will remember that State Street were fined a couple of years ago for  off millions from UK and Ireland occupational pension schemes, because those schemes trusted State Street to manage the complexity in the trustees and members interest – a trust that was betrayed.

A question of Trust

State Street got off pretty lightly, they didn’t have their license to trade removed and the big DC customers like Scottish Widows and NEST (for whom State Street provide the funds platform) , did not bat an eyelid.

I wrote to Toby Strauss at Scottish Widows asking for his reaction – I got no reply. I spoke to Laurence Churchill (then Chairman at NEST) and I got a wink and a tap on the arm. Nobody’s too bothered by a large investment bank committing white collar crime.

And despite this betrayal of trust, State Street are back selling the virtues of their complex opaque products  and people are buying into the slogan “there’s opportunity in complexity”

For those of you who missed the shenanigans revealed in February 2014, here is how State Street went about ripping their customers off. In this context, the phrase “there’s opportunity in complexity” takes on a new and sinister meaning.

This report first appeared on Bloomberg.

Today the UK Financial Conduct Authority settled a pretty similar case with some UK bits of State Street Corp., which the FCA found overcharged six clients by a total of just over $20 million. The Final Notice is full of funny quotes; let’s read some!

First there is Client A, who had a 4.7 billion euro portfolio to transition. It hired State Street’s Portfolio Solutions Group (“PSG,” or “EMEA PSG” since it covered Europe, the Middle East and Africa) to do it, for a flat management fee of 1.65 basis points, later reduced to 1.25 basis points for a portion of the trade. How did State Street decide on that price?

In deciding what bid to make to Client A, a series of emails were sent between members of PSG senior management which included the following comments on how revenue would be earned from the transition: “Gotta win this one! Any ideas how to get more revenue would be appreciated.” “How about a 1bp management fee or something of that nature, no commissions and then take a spread? We need to charge fee then otherwise they get suspicious.” “Just to clarify – 1.25bps is the management fee. The extra quarter point makes it look like we actually thought about it and did the calculations.”

My favourite word there is “the”: “we actually thought about it and did the calculations,” as though there were some math that could produce the right answer for how much State Street should make on these trades. There are no calculations! It’s just, what feels right to the client, what can you get away with, etc. State Street quite charmingly thought that a number with three significant digits would seem more real than a number with one, and that that would help it get away with more. Surely no one who takes the time to write three whole digits and a decimal point would rip you off. Only harmless nerds would write three digits where one would suffice.

But, nope, State Street, like ConvergEx before it, charged various secret undisclosed markups. State Street was supposed to make $1.6 million from Client A in agreed fees, but made an additional $3.7 million from undisclosed markups. Clients B, C, D and F are similar: State Street agreed to various small fees and then also took a bunch of larger undisclosed markups.

But my favourite is Client E, who did two fixed income transitions with a total value of about $6 billion. This client was focused on paying zero:

Following communications between EMEA PSG senior management and Client E prior to the first transition, in which Client E requested that no explicit commission be charged, EMEA PSG senior management proposed to undertake the transition on a zero commission (and no management fee) basis. In a series of communications between EMEA PSG senior management and Client E, EMEA PSG senior management made clear that State Street UK preferred to charge a disclosed commission, but in this instance it had arranged to receive: “a share of the spread from the ‘other side’ (the successful/winning counterparty for each individual security as chosen by us as your agent in a competitive bid process)”

So the FCA quibbles with State Street’s use of the “other side” — obviously, Client E was paying more to buy a security than its seller was selling it for, and that was going to State Street — but there are more interesting things going on here. For starters, note that Client E wanted to pay zero. Client E was not an idiot, or not exactly: It knew that it was going to pay State Street for its time and transition-management mojo. It just didn’t want to pay any explicit commission, for whatever reason, and that reason probably wasn’t a good one.

And State Street knew that, and said, no, please, we want to charge you an explicit commission. I like to imagine that this was because it knew that it couldn’t resist temptation. And there’s no temptation like zero commissions. Here’s how State Street management reacted to learning it was getting a zero-commission mandate:

On being awarded the second fixed income transition for Client E, members of EMEA PSG management exchanged emails commenting: “Nice!” and “Back up the truck!”

Right? State Street made $9.7 million on this one, almost half of all the overcharging that the FCA identified. There’s nothing more profitable than a zero-commission trade. If you’ve agreed to a 1.65 basis point commission, I guess you can go ahead and charge secret markups, but you’ll know that you’re being a jerk by doing it. But if you’ve agreed to do a trade for nothing? The client knows that you’re sneaking something in somewhere. They’re practically asking you to back up the truck. State Street was happy to oblige.

cyber crime


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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