- members won’t understand
- will be manipulated for self serving purposes
- will create further market distortions
- will support the promotion of self managed super
Quite rightly, at least in terms of transparency and comparability, the Cooper Review Panel concluded that:
“...the superannuation system lacks transparency, comparability and accountability in relation to costs, fees and investment returns”
As mentioned in my
September 2009 newsletter, there are at least 33 different strategies which I have observed where funds knowingly or inadvertently enhance the presentation of their relative fee competitiveness. Despite the Cooper Review’s obsession with fees and costs, the proposed new fee measure (Total Annual Expense Ratio or TAER) will only add to the market distortions and member confusion that has evolved, in part, due to an out-dated disclosure regime.
Only a handful of the 33 different strategies that I have observed are likely to be dealt with by the prospective new requirements. And unfortunately, further strategies are likely to be added to my list of 33 by virtue of the proposed changes.
In the spirit of the Cooper Review and its 489 pages, let’s focus on the detail!
Under the heading of investment management costs, there are three areas which are new, and may result in material changes in disclosure requirements and undesirable behaviour. Specifically:
- Brokerage fees
- Fees on underlying managers in fund-of-funds products to the first non-associated level
- Investment costs represented by the difference between gross earnings by a manager and actual returns remitted to the fund
Brokerage fees
The intentions behind the Enhanced Fee Disclosure regulations were to quantify for an investor the additional costs associated with investing via a collective investment vehicle (e.g. a superannuation fund). As such, brokerage is specifically excluded from Indirect Cost Ratio calculations as it is not an additional cost of investing via a collective investment vehicle.
The proposed TAER now includes brokerage as part of the cost of investment management. Whilst I am supportive of brokerage disclosure, rolling it up into a published fee which is focused on by members will have some very undesirable consequences. It also goes against the principle of providing investors with information on the additional costs of professional management via a collective investment vehicle.
Higher real cost outcome
Most share trading activity is undertaken on an agency basis. The broker acts as an agent of the investment manager, and therefore the superannuation fund, and there is an explicit brokerage fee for this service. In this capacity, in broad terms, there is an alignment of interests between the broker, the investment manager and the superannuation fund.
A smaller proportion of trading is undertaken by the broker acting as principal. The broker facilitates the purchase or sale by the investment manager by taking the opposite position (selling or buying the shares) on its own account. In this capacity, the role of the broker is adversarial and not aligned, and the fee is built into the negotiated price. The fee also compensates the broker for taking on the risk of the position, and therefore the real cost of the trade is higher, despite there being no explicit brokerage.
The requirement to include brokerage in published fees will result in an increase in principal transactions with brokers, given that there is no reported brokerage on a principal transaction. The burying of the costs within the transaction price will quickly eliminate the disclosure requirements, and enhance the perceived fee competitiveness of funds.
Think about the next time you change investment manager and engage a transition manager...will you choose:
- the low real cost option (agency trade) that will increase your published fee?
- the high real cost option (principal trade) that will enhance your perceived competitiveness?
First non-associated entity level
Fund of fund fees has been a key problem area of disclosure and comparability. Superannuation fund fee disclosure in relation to alternative asset fund of fund structures has been particularly contentious, with under-disclosure of true costs being common place. However, the proposed standards are potentially contradictory:
- Recommendation 4.13 (c) specifies “costs to be disclosed to at least the first non-associated entity level”
- Appendix 2 (page 133) indicates the inclusion of “fees of underlying managers in fund-of-fund products”
Firstly, the concept of disclosing fees to the first non-associated entity level continues many of the various distortions that exist today, and will create additional distortions in published fees:
- Existing market distortion: The published fee for investing in property via REITs will continue to be a fraction of the published fee relative to investing via unlisted property vehicles (yes, the flawed fee disclosure regime was a big contributor to the REIT bubble!)
- New market distortion: Superannuation funds investing via implemented consultants or other multi-manager vehicles will be able to just disclose the implemented consultant’s fees. The fees of the underlying managers will no longer need to be included in published fees, which is largely the practice today.
As mentioned above, the concept of “first non-associated entity level” appears contradictory to the requirement to “disclose fees of underlying managers in fund of fund products”. If the latter approach is taken, then in many instances we will see a material increase in disclosed fees. My work over many years would suggest that it has been rare for underlying manager fees in alternative asset fund of fund products to be included within published fee disclosure for superannuation funds.
As per brokerage, the concept of including underlying manager fees in products that an individual could rarely access goes against the current fee disclosure principles.
Investment costs represented by the difference between gross earnings by a manager and actual returns remitted to a fund.
Unintended consequences!?
All of these changes will see the published fees of superannuation funds increase. The higher published fees will feed into the hands of accountants and financial planners wishing to encourage superannuation members to establish self managed superannuation funds. So despite all the rhetoric around consolidation and the benefits of scale, these actions further encourage self managed superannuation (the anti-scale solution) at the expense of scale and lower costs of the overall Australian superannuation system. Go figure!
By the way, there are many points that I do like regarding the Cooper Review Panel recommendations. However, the ongoing damage caused by a continuation of the flawed disclosure regime, and further prescription creating more distortions is my hobby horse and I’m not ready to get off yet!
There is a solution to this mess
“Our primary interest as members should be the fees we are directly paying the superannuation fund trustee acting as our fiduciary, and, of course, any related party dealings and associated conflicts of interest. Whilst other fees and charges are of interest, they should not be our primary concern. It is the role of the trustee to make financial decisions on our behalf with the aim of achieving the best after tax, after fees returns. In this regard, fees are only one of many considerations.”
So there are essentially three pillars to this alternative disclosure regime:
- Disclosure of fees paid to the trustee acting as our fiduciary
- Disclosure of related party dealings of the trustee
- Disclosure of conflicts of interest
The alternative disclosure regime focuses on the concept of the role of trustees as fiduciaries. This role is entirely consistent with the emphasis from the Cooper Review Panel in reinforcing and strengthening the obligations of trustees to act in the best interests of members.