ANALYSIS

Time to make value judgements

Any discussion of fees and costs for pension funds should be within the context of “value for money” and not in absolute terms, Keith Ambachtsheer says.

“It is value for money that matters in pension fund management, not whether costs are high or low relative to those of a comparable group of peers,” Ambachtsheer argues. Are the benefits of scale being passed through to better member outcomes? This is the type of question that should be asked of the pension industry, he says, rather than focusing on fees.

In the February issue of The Ambachtsheer Letter, he quotes a report Australia’s Productivity Commission recently handed down that outlines criteria for assessing how efficient and competitive the superannuation system is at delivering the best outcomes for members.

He summarises the “sensible pension efficiency benchmarking proposals of the Australian Productivity Commission and offers a fast-track route to their implementation around the world”.

How the commission did it

The Productivity Commission’s approach was to define system-level objectives and formulate assessment criteria based on these objectives, then identify indicators to facilitate the assessment.

In other words, it asked, as Ambachtsheer puts it, “What are relevant…criteria? Or, stated differently, ‘How should pension system performance be benchmarked relative to the goals of adequate long-term net returns and pension protection?’ ”

The commission’s search for a suite of performance benchmarks led to five system-level objectives and 22 assessment criteria, supported by 89 unique indicators.

Assessing how competition affects efficiency is challenging. On the supply side, one must determine whether market concentration is a good thing or a bad thing. Meanwhile, on the demand side, competition is often driven by irrelevant information and unhelpful product proliferation.

Given these questions and considerations, Ambachtsheer says, the Productivity Commission suggests focusing on time series analysis – meaning asking questions such as whether competition is leading to a decline in industry fees and profit margins over time – or checking whether the benefits of economies of scale are being applied to benefit members.

The Productivity Commission report defines three types of efficiency in the development of performance indicators: operational, allocative and dynamic.

Ambachtsheer explains that net return is an example of a key system-level operational efficiency driver. Actual long-term net returns versus those of reference portfolios and CPI+X benchmarks are relevant indicators, and segmentation by member phase, asset class and geography are also relevant.

Another variable in operational efficiency is cost. Total costs should be captured and reported. They should also be separated into components, so the effects of such factors as fund size, investment policy and implementation strategies can be assessed and better understood when comparing efficiency.

Not reinventing the wheel

Ambachtsheer commends the Productivity Commission’s approach to the value-for-money question and explains that the wheel does not need to be reinvented in order to implement the commission’s recommendations.

CEM Benchmarking, of which Ambachtsheer is a co-founder and co-owner, has already designed and implemented many of the Productivity Commission’s recommendations. For example, on the cost side, CEM has extensive multinational net return, cost, organisational scale, structure/location, and reference portfolio databases, with information covering more than a decade for a group of 133 globally dispersed funds.

This data can be used to look at operational efficiency, which Ambachtsheer defines as net value added (NVA), or net return minus the reference portfolio return. Using the CEM data is revealing. For instance, when 10-year net value added is plotted against average operating costs, it reveals no correlation.

In other words, Ambachtsheer says, on average, paying more for asset management did not raise the net value added for the 133 funds measured in the database.

“Other recurrent research findings include a positive correlation between net value added and fund size, between NVA and proportion of assets managed internally (especially private-market assets), and between NVA and governance quality,” he says. “There is now a realistic opportunity to benchmark pension system efficiency – value for money – around the world, in a logical, consistent, comparable manner.”

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