There are many layers between an investment return and its ultimate consumer (the member?): a trustee or an insurer, an investment consultant, an investment manager, a custodian, a broker, a dealer and so on. There are many layers to an onion.
Each layer of an onion is opaque, this means that the next layer is partly obscured. Each layer of the delivery of an investment return is opaque making understanding the next layer more difficult.
If you cut open an onion, it can make your eyes water. Equally, if you look into an investment return, the costs can make your eyes water.
Railpen Investments recently finished an 18 month project to establish if they were getting value for money from their investment managers. To their surprise, they found that in addition to their upfront fees of £70m they were also paying upto £280m of additional fees, charges and costs.
The problem is the opacity of the layers. From the top layer it’s possible to have visibility, some understanding and so control of the layer beneath. However, it is far harder to have visibility, understanding and so control of the layer beneath that and so on - opaque layers mean less control. Railpen were paying those fees extra because they simply couldn’t see properly.
So what can be done?
Railpen had a particular way to solve the problem and in addition they were sufficiently resourced and had enough clout, but what about your average investor or trustee?
The regulators have an agenda of greater transparency but this is no easy job. In the recent past the IMA, the NAPF and the FCA have all engaged with the problem without, yet, success – not least of all because it’s quite difficult to define what a cost is (would you include the cost of research, the cost of in-house research, stock lending fees, foreign exchange commissions, or soft commissions?). Even if you can get beyond how to do it and what they are there are other problems.
Firstly, full disclosure can be counter productive. A line by line explanation of all costs relating to even a small portfolio would be a huge report. The shear volume of data would, in itself, obscure the facts. In other words, lots of communication is not good communication.
Secondly, disclosure in isolation is a waste of time. If a manager tells me that a deal had a cost of £10 I would have no idea whether that was good, bad or indifferent. I would need a comparator and no such thing exists. In theory an index could be developed, but often the dealing terms brokered by a manager are confidential.
Thirdly, there would be unintended consequences. Costs could be driven “underground”, quite legitimately, away from scrutiny. The further away from your layer the process, the less you will understand the ways to apply and/or bend the rules.
So should we give up trying?
No, but we do have to accept that there is no silver bullet solution to the problem of costs and their control in the investment process.
In the short term, the best that can be done is to create a chain of responsibility. The trustee engages the manager with binding terms to do the right thing including that they engage the dealer with binding terms to do the right thing and so on.
In the longer term by working hard together we will, gradually, peel back the layers to reveal what is there. With that we will understand and so be better able to control. Over time, as we gradually get to the centre of the onion, we will find ourselves in a less eye watering situation.