Transaction costs: questions for fund managers
Context:
Transaction costs are an important cost to pension funds. For trustees to fulfil their duty to act in the best interests of their beneficiaries, trustees must ensure that these costs are properly managed. The following is an indicative set of ten questions which pension fund trustees may wish to ask their fund managers, adjusting appropriately to fit the circumstances of their fund. Trustees’ advisers may wish to add to these.
Trustees should in addition seek to compare the answers given with those given by other managers, with a view to understanding the extent to which:
- the fund is incurring a higher or lower level of transaction costs through this manager than would be normal for similar mandates with this or other managers;
- the manager satisfactorily addresses conflicts vis-à-vis the commercial interests of the manager, associates and other clients, and their interests
- the manager is proactively seeking to increase efficiency of execution through innovation (including use of new dealing venues, new technologies, innovative contract structures and financial instruments).
Trustees should be clear that their responsibility is not simply limited to asking the initial question. Where appropriate they must challenge the resulting answers if they are incomplete or unsatisfactory. In line with the principles of investment, they should ensure that they have the appropriate skills and information to address these issues. In particular, they should ensure that those providing advice on these issues have expertise in transaction issues. Trustees should consider the full range of transaction costs, including custody, foreign exchange and deposit arrangements.
Ten questions:
1. What is your best view of the level of transaction costs – including not only commission but also market impact and opportunity cost - borne by our fund during the reporting period?
2. What action have you taken to minimise transaction costs while still dealing effectively?
3. Please explain any major differences between the level of costs incurred by you on our behalf and those incurred by other managers as reported in reputable surveys.
4. Were commission rates uniform across all transactions, and if not, what determines the commission rate on a transaction? Explain trend rates on these.
5. Which dealing venues and methods did you choose for our portfolio, why, and how did your choices affect our dealing costs?
6.Which brokers did you deal through and how did you select them?
7. Where you are not using an execution-only broking service, please list other services that you buy or benefits that you receive from the broker concerned (such as research and access to IPOs). Please explain how you evaluate the benefit these generate for us relative to the cost.
8. If you make use of both external research and in-house research, explain what distinguishes the former, for which we pay an additional charge, from the latter, which is covered by your management fee, and how you decide which to use.
9. Explain your rules on entertainment of your staff by brokers and those with whom you transact on our behalf where we bear the cost. Make available the records you keep, your policy guidelines and the approximate number, type and overall value of the events attended.
10. If you wish to make a case for soft commission arrangements, explain how our interests are better served by the broker providing you with services rather than securing lower commission costs for us.