LONDON (Reuters) - Pension funds are paying higher fees than five years ago to outside investment managers, but are not necessarily getting market-beating performance, according to research from consulting firm Watson Wyatt.
Fees now average 110 basis points a year, compared with 65 basis points in 2002, Watson Wyatt said. Much of this rise is due to high fees paid to investment managers of alternative assets such as hedge funds, private equity and real estate, as pension funds look for market-beating “alpha” returns.
But pension funds are often not getting value for money, Watson Wyatt said. “Investors have naturally assumed that they are paying these fees to reward manager skills, but in many cases they are wrong,” said Paul Trickett, European head of investment consulting at Watson Wyatt.
Instead of market-beating performance, many funds have simply got “leveraged beta” performance, where investment managers have geared up their portfolios to boost what are simply market-average returns when markets have been strong.
Worse, many pensions funds have unwittingly paid away much of the excess return they have earned in higher management fees, said Watson Wyatt.
Investment management fee agreements, which are generally poorly designed and tipped in managers’ favour, should be changed, Watson Wyatt said.
“Annual performance fees can amount to a free option for the manager,” it said, “as the upside is uncapped, but the downside is limited to the base fee.”
An ideal fee structure should have a low base fee, be calculated over three to five years rather than annually and should include hurdles, such as beating Treasury bills by a certain percentage, Watson Wyatt said.