Where should pension consultants be looking to find out how fund management charges impact pension funds? Emma Wall investigates
National press and politicians have been waging a war on pensions. Workplace schemes have been labelled indecipherable, high charging and slow moving – accused of putting the priorities of pension savers last.
The Office of Fair Trading (OFT) paper published in September concluded schemes were over-complicated and difficult to understand. A proposed cap on new style pension funds followed last month, proposing auto-enrolment pension funds charge no more than 0.75 per cent a year, or possibly up to 1 per cent where the employer can justify it.
Backlash from the industry argues that it is almost impossible to run a competitive actively managed portfolio on such a figure – especially when fund managers themselves do not reveal their underlying costs.
Indeed, even the Government’s own default auto-enrolment scheme, at first glance, fails to comply with the proposed charges cap. Nest’s charge of 1.8 per cent on contributions and 0.3 per cent in annual management charges means the Government is going to have to be creative in how it frames any cap.
“Charges can reduce the amount left in members’ pots when they come to retire, and it’s important that members get value for money. However, we also need to focus on final outcomes for members,” says Nest chief investment officer Mark Fawcett.
“Our charge includes all administration, custodian and investment management fees and our investment strategy aims to significantly exceed CPI after all charges have been taken out.”
While market returns help this figure to be reduced over the long term to an average of 0.5 per cent – it does raise concerns about how pension funds can ever consistently hit a 0.75 per cent annual charge cap, if that is where the DWP consultation finally ends up.
The meaningfulness of a charge cap is also thrown into question when so few fund managers refuse to play ball and fully disclose charges. When this magazine contacted six leading fund managers last year, all but one refused to disclose how much of their research costs are paid for off balance sheet and therefore not included in AMC or TER figures, through broker commissions.
Artemis, Fidelity, Invesco Perpetual, M&G and Schroders all refused to reveal how much they spend on research through broker commissions through their flagship funds, just weeks after the then-FSA reported poor practice in relation to broker commissions from asset managers.
Standard Life was the one manager who complied with the request concerning its £13.3bn GARS fund. The asset manager said around 2.6 basis points of the fund goes towards research paid for by broker out of commissions, meaning it spent around £3.42m on broker commissions.
Standard Life head of workplace strategy Jamie Jenkins said that there was a considerable amount of work being done to improve disclosure of charges to both employers and employees.
“This will mainly cover the AMC and any additional expenses, such as audit or custody fees associated with the choice of investment fund. Most of the big providers are committed to delivering on this over 2014 and 2015.”
One area of charges which is not as easy to disclose is transactional costs. Although less common for the insured funds mostly used in pension default arrangements these include brokerage fees and stamp duty, the costs of which are dependent upon the level of trading required in the fund and so fluctuate.
“Including transaction costs within any charge cap would either make it very difficult to ensure compliance, due to the variability of the cost, or restrict the fund manager in making trades, potentially reducing their ability to deliver against its objectives,” continues Jenkins. “This would undoubtedly restrict the availability of default funds for employers and their employees and we do not believe this will lead to better member retirement outcomes.”
While asset managers may profess commitment to charge transparency, without legal or political pressure it simply will not be a priority for the City.
Pensions minister Steve Webb’s plans to cap annual pension charges bear a remarkable similarity to proposals from the opposition that were rejected by Webb a year earlier. Now it’s the opposition again who are pushing the charges agenda – this time concentrating on fund management.
In a suggested addition to the Pensions Bill, shadow Pensions Minister Gregg McClymont said that a pensions cap alone was not sufficient to ensure value for scheme members. He said there needed to be full transparency when it came to investment charges.
McClymont stated in September that the Investment Management Association’s Statement of Recommended Practice on Investment was not extensive enough. The IMA had recommended that an ongoing charges figure (OCF) replace the AMC as the comprehensive picture to investors.
Director of public policy at the IMA, Jonathan Lipkin, says that EU fund regulation offers a useful conceptual approach in the form of the OCF, calculated and presented in a comparable way in every UCITS. He says: “Pensions are clearly not the same as investment funds, but they need their own equivalent of the OCF – a consistent standard that cannot be disputed.”
But McClymont said that there were still certain costs missing from this figure – such as the bid-offer spread and all the transaction costs of underlying funds in multi-manager portfolios. He also highlighted that any interest earned on cash holdings or asset lending where omitted.
McClymont said that ending “pensions rip offs was a key part of tackling the cost of the living crisis”.
In a direct attack on the ABI and IMA he continued: “Decisions on costs and charges cannot be left to trade associations whose members have a potential interest in not declaring all charges.”
Aegon investment director Nick Dixon says FCA regulated firms already provide extensive information on charges and the ABI code which his company has signed up to will provide further clarity on these – but there that is scope to improve disclosure of charges within trust-based schemes.
But Dixon does not completely agree with the increased focus the industry has put on charges. “Charges are only one aspect of pensions and we need to make sure people receive information on these in the context of the benefits they receive. What we don’t want to do is bombard people with even more information which they simply don’t read. Charges are only one of a number of factors that retirement outcomes for pension savers,” he adds.
This point is backed up by the conclusions of the OFT report into DC schemes. The paper found that schemes were over-complicated and difficult for members to understand, and called for the Pensions Regulator to take action – and for the Department of Work & Pensions to launch a consultation into transparency and charges.
Now: Pensions chief executive Morten Nilsson agrees that regulators must act to crack down on charges as it will be scheme members who will be hurt the most – and in time this will do long term damage to the already-suffering reputation of the pensions industry.
“The charging structures used by some schemes are masked in complexity,” he says. “There are still huge differences in what charges are disclosed by which funds. AMCs are not an accurate enough measure of what a member pays and there is inconsistency in what the AMC contains. Some quoted AMCs already include additional expenses that would otherwise be added to create a TER, so the DWP needs to clearly define what is included in the charges quoted by schemes.”
At the Corporate Adviser Summit in October, Chris Sier of Stonefish Consulting said that it should not be left entirely to the regulator to put pressure on fund management – Advisers and trustees need to be far more demanding of fund managers about the true cost of funds.
In an animated speech, Sier accused fund managers of treating advisers and trustees like “mugs” and said that the TER does not reflect the true cost of ownership as it excludes other costs, such as foreign exchange.
Sier continued: “There is no one figure that captures all these costs, regardless of what the IMA says. Reducing costs by 1 per cent improves your pension fund performance by 25 per cent.”
Barclays Corporate & Employer Solutions head of investment proposition Jonathan Parker says that no further measure of calculating fund charges is needed – rather, the industry should concentrate on making the existing measures accurate.
“We do not believe that introducing a further measure of charges would be of benefit. The industry already has TER, AMC and OGC,” says Parker. “It would be far better to agree what is and what is not included in the TER and ensure this measure is transparent and consistent. If there are elements of charges not currently included in the TER, then TER should be redefined.”
Nilsson does concede that the fund management industry is at least making headway – and that it is possible to be transparent without overloading the members with unnecessarily complexities.
“The industry has struggled with transparency for many years, but it looks like there is now a concerted effort to put this right,” he said. “The challenge is to be fully transparent without overloading members with confusing information. We believe in complete transparency to advisers and scheme sponsors while for members, transparency must be considered alongside simplicity of message.”
He said that if a charge cap was introduced all charges should be included, including transaction charges – but that this detail does not necessarily have to be communicated to members within standard literature.
Instead, full details on charges should be easily available to those members who have an interest, while a kite mark equivalent – such as the one currently being rolled out by the government for simplified savings and insurance products – could be used to confirm that the scheme charges’ fall within the cap.
While transparency should be firmly on asset managers’ agenda, there are concerns that a price cap on pensions would stifle innovation – and push schemes towards passive management.
Hargreaves Lansdown head of corporate research Laith Khalaf says that pricing pressure, while positive for the employee, can have a detrimental effect on the investments.
“Very few schemes will be able to afford to run an actively managed portfolio on 0.75 per cent,” he argues. “It may mean that all default schemes simply become a basket of tracker funds.”
Many pension providers already offer a pure passive option – and it’s not just confined to institutional investment. Standard Life, for example, has launched a range of Passive Plus Pension Funds that offer investors access to a broad range of assets, including equities, bonds and property, all through tracker funds.
An Evercore paper found that a diversified portfolio selected purely on the grounds of lowest cost for pension schemes would comprise 58 per cent exchange traded funds, 40 per cent index-tracking funds and 2 per cent cash. The tracking difference of this portfolio in 2011 would have been a positive 0.08 per cent – in other words, it would have just beaten its respective basket of indices – and including all purchase costs would have cost only 0.1 per cent in its first year.
Hymans partner Mark Jaffray says: “Do managers truly believe passive management is better? Or is it a way to reduce the cost to the member? It is probably both, and also due to the lack of scale in funds under management that any of them currently have.”
The downward pressure on costs – both market driven and those exerted by regulation and the government are fundamentally good for pension savers. But cost cannot be considered in isolation – nor be prioritised above end performance. In order to ensure that members are able to enjoy their retirement trustees must not be forced to opt for low-cost instruments where inappropriate.
“The quality of funds is extremely important for member outcomes, which means that trustees and employers must also look at governance frameworks, consumer experience, and investment strategy when selecting a provider,” says Nilsson. “With charges under pressure, it’s almost inevitable that some providers will be tempted to push members into cheaper, passively managed default funds which won’t necessarily deliver the risk managed returns savers deserve. This could be a potential threat to the success of auto-enrolment.” n