The topic of transparency of costs and charges refuses to go away. Significant costs are still not being disclosed fully to asset owners who often have no idea of their potential impact. I recently heard a discussion about value for money which summed up the current thinking about cost disclosure and saving – whilst it is a worthy exercise, one that people care passionately about in some cases, it isn’t as important as seeking investment return for DB schemes. This made me think – why don’t we consider costs and asset allocation in the same governance bracket? Why does cost transparency exist outside regular investment strategies, recovery plans, monitoring, and so forth? Are we thinking about it the wrong way?
Quite simply, yes. Costs have a significant impact on return and should be viewed as part of any DB scheme’s flight plan. In reality it can be a little more complicated than that, but stick with me.
In the wake of the BHS pension fund crisis I decided to examine their numbers and some initial napkin calculations have provided some interesting observations. The 2015 annual accounts quote total expenses of 44bps based on closing net assets; however, this obviously falls short of a reasonable estimation of actual costs incurred. Research shows that the true cost of investment for pension schemes after full cost disclosure is actually somewhere between 2-5% per annum. So, if we approach the BHS accounts conservatively and say the true costs are at 2%, this increases their cumulative cost base over a 15 year period from £28m to a whopping £128m.
Now, not all these costs are “bad” or unrewarded, but if we learn anything from the introduction of cost transparency in the Netherlands, it is that many can be negotiated down if you know about them. If BHS had known about these costs and reduced them by a percent to a nice, simple 1% per annum that would equal a real saving of £4.3m last year alone. But remember that the scheme doesn’t just save money; they actually receive that saving as an increase in return to the scheme. That is 1% additional performance.
If you look at the value of the BHS scheme over the period between 2000 – 2015, the rough average annual return is 1%. So, if cost transparency and subsequent saving means a 1% increase in return, then this effectively doubles return. All highly theoretical and over simplified, but it makes you think. In practice, the outcome might not be quite so dramatic but there is something to it.
We’ve got a long way to go as an industry to close the cost governance gap with our friends on the other side of the North Sea, but momentum is gathering. However, if we don’t look at costs as a core element within investment performance then we’re missing the key point. In the case of BHS, if my simplified scenario had played out, the scheme could have saved an additional £100m over that 15 year period, significantly greater than the £80m Sir Philip is offering.
The industry needs to join together to push for reasonable cost reporting in order to reap the rewards, but this is still met with resistance in some quarters. My job as a custodian is to secure, protect and develop value for pension funds, and I believe giving them transparency around all their costs is fundamental to this. However, rather like a motto of BHS itself, turned on its head, this concept certainly is stylish but it most definitely isn’t made simple.