Rising fee levels for investment managers in Hong Kong and worldwide require plan sponsors to pay more attention to what kind of value their external fund managers deliver, says Naomi Denning, regional director of investment consulting at Watson Wyatt.

Last week at the consultancyÆs annual seminar covering manager investment performance for the $73 billion Hong Kong pensions market, Janet Li, a consultant at Watson Wyatt, revealed RCM and Schroder Investment Management have exhibited the best risk-adjusted performance in Hong Kong retirement funds over the past three and five years.

Judged by Sharpe ratios, both scored 2.22 over a five-year period, and near-identical scores of 2.73 (RCM) and 2.72 (Schroders) on a three-year basis. Both outpaced rivals by a considerable margin over both timeframes. The third-best risk-adjusted performance over five years was Baring Asset Management (2.09), while AllianceBernstein ranked third over a three-year period (2.41).

Last year, the best five-year risk-adjusted performance figures were claimed by RCM as well as Credit Agricole Asset Management and Fidelity Investments, which shows how even risk-adjusted performance can vary. (These numbers should not be taken in isolation as endorsements by Watson Wyatt.)

Li notes 2007 was the fifth consecutive year of positive gains for Hong Kong retirement assets, and their strong home bias meant the average pension fund enjoyed returns over 20% last year. This year more funds will have to revisit the issue of currency hedging, which can eat into returns, but should do so based on their core beliefs about major things like the fate of the Hong Kong dollarÆs peg, not to chase returns, she says.

She also notes that 2006 marked the turning point in MPF when, judging returns since the schemeÆs December 2000 inception, high-equity content funds outpaced more conservative ones. The evidence supports the benefits of dollar-cost averaging and Li says while rising volatility may require some members to adjust their asset allocation, employers should not encourage frequent switching.

ôDefined-benefit funds now enjoy funding surpluses, and many are closed, so maybe now is a good time to consider de-risking,ö she adds.

Pension plans need to pay more attention to the value they are getting from managers, however, as fees have risen. In 2002, average fees were high in Hong Kong, with plan sponsors paying 91 basis points û far more than the global average fee of 63bps, which was put down to higher transaction costs in Asian markets.

Today these have converged: global average fees paid by pension funds are 119bp, and 120bps in Hong Kong. The lionÆs share of these continue to go to investment managers, with modest increases to brokers; custody and consulting fees have always been slight.

This massive fee rise is not from core, traditional fund managers but from the plethora of new alternative or absolute-return products, including hedge funds, private-equity funds and niche funds with capacity constraints. These often charge 200bps plus a 20% performance fee. To some extent the higher trading costs in Asia remain so this convergence also shows to what extent Hong Kong plans have only begun to adopt alternative strategies.

ôAre pension funds getting value for these higher fees?ö Denning wonders. The answer: sometimes, but plan sponsors need to be realistic about their ability to actually identify the best managers, and whether the alpha they are supposedly receiving is justified by those fees. For plan sponsors with very basic governance structures, cheap passive investments are probably best.

ôIn the past weÆve often advised plan sponsors to not get caught up on fees,ö Denning says, noting with traditional mandates, trying to squeeze another 10bps from the manager was a waste of energy. But the advent of more choice, the need for alpha and the high costs of alternative strategies have changed the rules of the game.