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ITEM PF13

PENSION FUND COMMITTEE – 21 NOVEMBER 2003

REPORT OF OFFICER MEETING WITH ABN AMRO MELLON

Report by the Head of Finance

1. On 17 September 2003 Mr Bushell and Mr Wheeler visited the Pension Fund’s custodian, ABN AMRO Mellon in London, to discuss a number of outstanding issues. The issues raised are summarised in the following report together with any recommendations.

Commission Recapture

2. The Oxfordshire Pension Fund has participated in a commission recapture programme since July 2000 through Frank Russell Securities and this has been a very successful venture generating income for the Fund of £22,000 in 2000/01, £32,000 in 2001/02 and £32,000 in 2002/03.
3. Under the Fund’s previous management arrangements both Schroders and Deutsche Asset Management participated in the commission recapture programme. Under the new management structure only Alliance Bernstein has agreed to participate so the Fund is unlikely to receive as much income as it has in the past, though it should be noted that it is equity trades that tends to generate the most income.
4. The Council has been pleased with the quality of service provided by Frank Russell. They use a large list of correspondent brokers, which increases the scope for generating higher commission. During the Global Custodian tender process we asked tenderers if they were also able to provide clients with a commission recapture programme and ABN AMRO Mellon reported that they were able to do so.
5. We have asked ABN AMRO Mellon to report to the Council on the amount of directed commission that they would earn for the Oxfordshire Pension Fund if they operated a commission recapture programme. They will base this on Alliance Bernstein’s actual trading over the next six to twelve month period. The results of this exercise can then be compared with the actual directed commission earned by the Frank Russell programme over the same period. Officers will report on the outcome of this exercise to the Committee during 2004/05 together with any recommendation.

Standardised Proxy Voting Report

6. ABN AMRO Mellon was asked if they were able to produce a quarterly voting report detailing Company AGM or EGM resolutions and reporting how each of the Fund’s managers voted.
7. They are not able to provide this information in the required format at the moment but intend to do so in the future. I will keep the Committee informed on this matter. In the meantime the Fund Managers themselves have been instructed to report their proxy voting.

Risk Reporting

8. A representative from Russell Mellon CAPS explained that they were still working to improve the quality of their risk reporting process. Mr Wheeler reported that they had terminated this service at the beginning of 2003 because they had not been receiving the reports by the committee deadline dates.
9. After the new managers were appointed, Mr Wheeler either met or corresponded with them on the issue of portfolio measurement risk, and asked if they were able to incorporate a page on risk measurement within their quarterly reports. All four managers are happy to do this and supplied examples of what they would produce.
10. Mr Bushell feels that the information that the managers are willing and able to supply is sufficiently detailed to enable us to monitor the degree of active risk being taken. We do not feel there is any merit at the moment in subscribing to an independent risk management service.

Transaction Cost Reporting

11. The Myners Report on Institutional Investment recommended the desirability of understanding and monitoring transaction costs. At the moment the Pension Fund does not fully comply with this principle and the fact that we do not is recorded in the Fund’s SIP (Statement of Investment Principles). However, it should be noted that this important subject has not been overlooked altogether as evidenced by the recent successfully carried out transition management exercise.
12. There is a UK industry sponsored disclosure code requiring fund managers to provide their clients with a breakdown of broker commissions and trading costs. However, the information that has to be disclosed is mainly the smaller transparent costs and not the larger indirect costs such as market impact and timing.
13. Mr Wheeler and Mr Bushell received a detailed presentation by Inalytics, who have formed a strategic partnership with ABN AMRO Mellon to provide a transaction cost analysis service. Inalytics currently has 42 clients made up of both Fund Managers and Pension Funds.
14. Inalytics explained that commission expenses only formed a small percentage of transaction costs. They said that the average UK transaction costs was 101 basis points of which 16 basis points related to commission and 85 to the less transparent impact and timing costs. The transaction costs on overseas markets tended to be even higher.
15. Annex 1 gives an example, provided by Inalytics, of the level of transaction costs that might be incurred by an equity portfolio. Equity trades tend to incur higher transaction costs than bonds. Based on a pension fund with an equity portfolio of £400 million and a turnover of 120% (purchases of 60% and sales of 60%) the estimated annual transaction costs would amount to £4.8 million. However, it should be noted that two of Oxfordshire’s managers have a value investment style, which tends to produce a lower investment turnover. We have asked Inalytics to produce an estimate of Oxfordshire’s transactions costs based on its trading activity. However, it may be several months before any meaningful trading data becomes available.
16. It should be emphasised that a portfolio’s overall investment performance is of more importance than trading costs. High trading can be tolerated and justified if it produces superior performance. The important consideration is whether trading is unnecessarily excessive and therefore eating into the investment return.
17. The benefits of this service were summarised as identifying excessive commission rates, dealing inefficiencies and a means of comparing managers dealing expertise.
18. We were provided with examples of Inalytics quarterly reports, which we felt were clear, concise and very informative. The cost of this service to Oxfordshire would be £15,000 per annum. Were we to subscribe to it the results would be incorporated into the quarterly performance measurement service that we currently receive from Russell Mellon CAPS. The service would also include an annual presentation by a representative from Inalytic to the Committee and their attendance at any other meetings as and when required.
19. Inalytics said that there was evidence that where managers trading costs were being measured trading costs had been reduced. Based on the example provided in annex 1 a reduction in trading costs of just 1 basis point equates to an annual saving of £48,000.
20. Mr Bushell and Mr Wheeler believe that subscribing to this service would enhance the process for monitoring the Fund Managers investment activity. Unusually high or low trading patterns might help to identify critical changes in a manager’s investment behaviour. It is difficult to quantify any potential savings but we fully subscribe to the Myners view that "transactions are an important cost… and that Trustees must ensure that these costs are properly managed".

Securities Lending

21. A presentation was also received on securities lending and Mr Bushell has written a separate report on this issue, which appears elsewhere on the Pension Fund Committee agenda.

RECOMMENDATIONS

22. The Committee is RECOMMENDED to:

1. request officers to provide a further report on Commission Recapture in 2004/05, following the receipt of costing analysis by ABN AMRO Mellon based on at least six months trading activity by the Oxfordshire Pension Fund;
2. request officers to report back on ABN AMRO Mellon’s new proxy voting report as soon as it has been produced; and
3. subscribe to the Inalytics Transaction Cost Reporting Service.

CHRIS GRAY
Head of Finance

Background Papers: Presentations by ABN AMRO Mellon and Inalytics TVA.

Contact Officer: Tony Wheeler, Pension Fund Investments Manager. Tel (01865) 815287

November 2003


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