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ITEM PF15
PENSION
FUND COMMITTEE – 25 FEBRUARY 2005
MONITORING
TRANSACTION COSTS
Report by
the Head of Finance & Procurement
Background
- In August 2002
Local Government Pension Scheme regulations came into force requiring
administering authorities to report, in their Statements of Investment
Principles, to what extent they comply with the ten investment principles
contained in the CIPFA document "Principles for Investment Decision
Making in the Local Government Pension Scheme in the UK".
- Two reports went
to the Pension Fund Committee during 2002, which reported that the Oxfordshire
Pension Fund complied with all the principles, except on shareholder
activism and the monitoring of transaction costs. The Pension Fund’s
latest Statement of Investment Principles reports that these two principles
are still not complied with.
- This report investigates
the current position on the progress made with the monitoring of transaction
costs. A report on shareholder activism is being considered separately
at this meeting.
- The CIPFA Principle
number 5 says "Trustees, or those to whom they have delegated the task,
should have a full understanding of the transaction-related costs they
incur, including commissions. They should understand all the options
open to them in respect of these costs, and should have an active strategy
– whether through direct financial incentives or otherwise – for ensuring
that these costs are properly controlled without jeopardising the fund’s
other objectives."
What are
transaction costs?
- Annex 1 (download
as .doc file) provides a flow chart, which shows the main steps
in turning an investment decision into a completed trade in the market.
This is the context in which transaction costs are incurred. The chart
identifies four different stages in the trading process – order generation,
broker selection, order placement and order execution. The simplest
way of identifying the cost of any transaction is the difference in
stock price between the price available in the market at the time the
order was generated and the net price of the execution (i.e. the price
including commissions, fees and taxes).
- According to research
by Inalytics, a company specialising in measuring transaction costs,
the average cost for a UK transaction is 101 basis points of which 16
basis points relates to commission and 85 to the less transparent impact
and timing costs. The transaction costs on overseas markets tend to
be higher. Annex 2
provides further details on the different elements of transaction
costs.
Monitoring
Transaction Costs
- In May 2002 the
Investment Management Association ("IMA") published a Code of Practice
on the disclosure of costs and charges incurred in the management and
custody of scheme assets. The Code was drawn up by a Joint Working Party
of Members of the IMA and the National Association of Pension Funds
(NAPF) and was endorsed by the NAPF Investment Council.
- Level One of the
Disclosure requires managers to set out their policies, procedures and
control processes on certain issues such as broker selection, dealing
efficiency monitoring and conflicts of interests. Level Two covers the
reporting of numerical and statistical information on commissions and
use of brokers. Oxfordshire’s four fund managers comply with both Levels
One and Two of the Disclosure Code.
- Level Two information
is now reported within the managers’ quarterly valuations but it is
the larger costs such as timing costs and market impact, which are less
easy to monitor. These less transparent costs are not included within
the Level Two reporting.
- The Pension Fund
Committee received a report in November 2003, which recommended that
the Oxfordshire Pension Fund should subscribe to the Inalytics Transaction
Cost Reporting Service. The attraction of this independent service was
that it measured all transaction cost elements and enabled comparisons
with a universe of other pension funds and managers. The cost of this
service was £15,000 but after the two managers present at this meeting,
Baillie Gifford and UBS, offered to share the information they get from
their own external specialists, it was decided not to subscribe to an
independent measurement service for the time being.
- All four of Oxfordshire’s
managers use third party specialists such as Elkins/McSherry, Plexus
and Abel Noser. During the last twelve months, the officers and Independent
Financial Adviser have seen copies of the various external reports used
by the managers, and have discussed the results and conclusions with
them. In all instances officers were satisfied that the Pension Fund’s
transaction costs were at a reasonable level and more often than not
well below the benchmark average. The monitoring of transaction costs
is now a standard agenda item at the officer/manager meetings.
- Legal and General,
who manage the Fund’s bond portfolio, have not been asked for an analysis
of trading costs as they deal net (i.e. do not pay commissions) and
in highly liquid markets for most bonds. Moreover, the Pension Fund
did use Legal and General as the transition manager to move the Fund’s
portfolio from two balanced managers to the current four specialist
managers as their tender cost was estimated to be the lowest.
Conclusion
- Since the last
occasion when officers reviewed the monitoring of transactions costs
much progress has been made. All four managers now comply with levels
one and two of the IMA Disclosure Code. The more transparent costs like
commissions and fees (IMA level 2 costs) are reported to the Committee.
The less transparent costs, like market impact and timing, are measured
and monitored by the managers, who employ external specialist firms.
Figures and statistics from the reports are shared and discussed with
the officers and Independent Financial Adviser at the officer/manager
meetings held throughout the year.
- The Pension Fund
has signed up for a transaction measurement service with Euraplan. This
service is being provided free for a trial period and will compare Oxfordshire’s
transaction costs with other local authority pension funds. Officers
will keep members informed on the progress and results of this project.
RECOMMENDATION
- The Committee
is RECOMMENDED to note this report and to amend the Pension Fund’s Statement
of Investment Principles to reflect that the CIPFA principle covering
transaction costs is now being fully complied with.
SUE
SCANE
Head of Finance
& Procurement
Background papers: CIPFA document "Principles for Investment Decision
Making in the Local Government Pension Scheme in the UK" Data supplied
by Alliance Bernstein, Baillie Gifford and UBS
Contact
officer: Tony Wheeler, Pension Fund Investments Manager Tel: (01865)
815287.
February
2005.
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