| Paul Myners | ||||||
It may have been buried towards the back of a long report but it has certainly elbowed its way into the spotlight since. A call by Paul Myners, in his review of the UK’s investment industry, to address how and why fund managers pay commissions to brokers has sparked a heated debate.
At the heart of his proposal is the idea that there is too cosy a relationship between brokers and fund managers. The main target of his criticism is the practice of brokers giving fund managers soft commissions, or soft dollars, in return for their orders.
Myners, the chairman of Gartmore, was clearly aware of the possible reaction his views might provoke. “I think a lot of people were surprised by my proposals on commissions – after all, this is about a 50-year-old tradition,” he said.
Although soft commissions, or soft dollars, most commonly involve the broker providing research to the fund manager in return for trading commissions, other forms of payment are sometimes handed over. At one end of the spectrum this means brokers providing fund managers with Bloomberg terminals. At the other extreme, the markets abound with dark tales of freebies and bribes being used to help secure business.
Much of Myners’ recently unveiled Review into Institutional Investment in the UK has been widely accepted by the industry. The need to do away with the minimum funding requirement – which was brought in following the Maxwell/Mirror Group pension fund affair – and a desire to assess more accurately the investment advice of consultants are both seen as good ideas.
However, his views on commission fees have not been so warmly welcomed.
Myners says fund management fees charged to pension fund clients should incorporate the costs of commissions paid to sell-side firms, rather than these being charged separately to the client. It sounds straightforward enough.
Fund managers currently pass on the cost of commissions to their funds as an inevitable transaction expense. But Myners claims that much of the research fund managers make their clients pay for is either of poor quality or not used at all.
He points out that fund managers themselves complain about how bad investment bank research is, yet still charge their clients £1.5 billion ($2.1 billion) a year for it.
His idea is directed at pension funds but he says it could equally apply to unit trusts. “When a pension fund hires a fund manager to manage its investments, the fee it pays is clearly visible as a single sum,” he argues. “It is negotiated when the fund hires a fund manager.”
When the fund manager trades securities on his client’s behalf through an agency broker he pays a commission on every trade. In return the fund manager gets access to services from the broker, such as his research.
In some instances these commissions may be as much as the fund management fee. Myners argues, however, that they are treated differently. “They are not reported in a transparent way,” he says. “They are shown as an extra cost on each individual transaction, not as a single sum over, say, a quarter, as the fund management fee is.”
The client has no direct say in which broker handles trades and yet he, not the fund manager, bears the cost. Myners says that while it is accepted practice in any business to contract out part of the day-to-day running of an operation, in this case trade execution, the passing back of the costs to the client is not.
Above all, he questions whether the services provided by the brokers are worth the commission paid and says pension funds are not in a position to assess this, while fund managers are. For this reason his review proposes that the cost of outsourced research be included in the fund management fee.
If the proposal is taken up it is argued that brokers could increase the spread between buy and sell prices. However Myners says this disregards market forces and fund managers’ obligation to pursue best execution.
Unfortunately for Myners, his campaign took a big blow before it had even had time to get off the ground when the National Association of Pension Funds failed to back it at its annual conference last month.
Alan Rubenstein, chairman of the association’s investment committee, in closing the conference supported much of Myners’ report but said it needed to think more on commissions. Myners’ recommendations have been put into a voluntary code and a review two years from now will examine to what extent they have been followed. After Rubenstein’s speech it seems unlikely the NAPF will take the lead in encouraging reform of commissions. Myners did not seem too surprised by the NAPF reaction. “Pension funds are very conservative people, prudent people,” he says.
This is unlikely to be the end of the matter, though, and it has brought the issue into the open, with the UK Treasury also showing interest. “The government believes that Paul Myners’ proposal – that fund management fees should include the cost of commissions – is the right way to deal with this issue and this arrangement would serve the interest of pension-fund members better,” says Melanie Johnson, economic secretary to the Treasury.
Set against this is the question of how much political will the government has to push reforms through, particularly as they are unlikely to win it any votes. The NAPF’s lack of support may also prove significant.
Robert Matthews, managing director at Royal&Sun Alliance, says he thinks it unlikely that the government will legislate on the report. It has threatened to if pension funds do not either follow Myners’ code of practice or explain to their members why they have decided not to follow it. “There’ll be enough of a move for government action to be unnecessary, but it will be more in areas that don’t affect costs so much – such as training trustees in finance – rather than in the whole area of commissions,” says Matthews. “There are a lot of vested interests around that issue.”
One of the problems is that people are not sure what exactly does constitute a soft commission. Some think it is anything outside pure execution cost. Others see it differently. “There seems to be a huge difference of opinion as to what soft commission actually means,” says a source at a leading UK brokerage house. “From our point of view we would be more than happy to get rid of them.”
The broker says that fund managers and their clients will be better served by going after good performance rather than commissions. “I don’t think we have cosy relationships,” he says. “It is a dog eat dog world out there.”
However, for those people who think relationships are cosy now, they might like to consider how far things have come. One London fund manager tells a story of how business used to get done when he was first in the City. “The head of my old firm would bring all the brokers in at the start of the year to determine how much he was going to pay out in commissions to each of them,” he says. “Then at the end of the year they would meet again and if one firm had taken more than they had agreed and another less, he would get them to write a cheque for the difference and hand it over.”
It is hard to see that happening in today’s market.
A version of this story first appeared at: www.euromoney.com/assetmanagement
