Volatility-managed funds charging up to 1.15 per cent can deliver a narrower band of outcomes to scheme members without putting them at risk of lower returns, according to research from the Pensions Policy Institute.
The research suggests that the current 0.75 per cent charge cap for auto-enrolment defaults is shoehorning members into schemes that deliver a wider than necessary range of outcomes because there is insufficient room within the charge to pay for volatility management.
The PPI report Value for Money in DC Workplace Pensions calculates that by paying a charge of 1 per cent for a fund with volatility management an individual would have a 75 per cent probability of avoiding the worst outcomes, without losing out on overall performance. With a charge of 1.15 per cent, a volatility-managed fund could see individuals have a 95 per cent probability of avoiding the worst outcomes. Where charges exceed 1.15 per cent, costs start to reduce overall returns.
Standard Life says the research, which it commissioned, highlights potential negative outcomes should the review of the charge cap, penciled in for next year, recommend a reduction to 0.5 per cent or the inclusion of transaction costs.
The PPI has also modeled a 100 per cent equity fund with lifestyling during the last 10 years of the fund, with a charge of 0.35 per cent, against a volatility managed fund that achieves the same return as equities but with only 67 per cent of the volatility (see graph). This fund has a charge of 0.4 per cent for volatility management in addition to the annual charge of 0.35 per cent.
The results, which are theoretical and not based on actual funds’ actual returns, show a median value for the lifestyle fund at retirement of £210,450 compared to £220,507 for the volatility-managed fund, with a smaller range of outcomes for the volatility-managed fund. The median value is higher for the volatility-managed fund because lifestyling is not applied during the 10 years up to retirement.
The PPI found that the 10th percentile pension pot value is 48 per cent for the lifestyle fund and 53 per cent for the volatility-managed fund, while the 90th percentile pension pot value is 207 per cent for the lifestyle fund and 202 per cent for the volatility-managed fund.
PPI director Chris Curry says: “The 1.15 per cent figure is the tipping point. If you go beyond that you stop gaining the benefit of the volatility controls and the charges start eating into performance.
“But I must stress these scenarios are hypothetical to highlight the trade-offs involved, rather than to say ‘you should choose a volatility-managed fund rather than a low-cost equity fund’ because we don’t know what are the particular characteristics of each fund. This is designed to highlight that there is more than one feature that is relevant in value for money. If you focus on one at the expense of others, that might be the right thing to do but you need to know what it is you are giving up.
“Whether that means the 0.75 per cent charge is too low depends on whether you think charges in the industry can come down further.”
Standard Life Jamie Jenkins says: “ We can take it as read that charges might differ by 70-80 bps, from 20 to 30 bps at the lower end compared to 1 per cent for non-qualifying schemes. But the annualised returns from different defaults are varying by between 700 and 800 basis points.
“We offer auto-enrolment schemes to all employers, with an admin charge of £100 a month, that has been waived for the first year. For that they are getting similar services to what the largest employers are getting. If the charge cap is reduced further, it would raise questions over whether we can continue to offer the same service to all employers, particularly if trading costs were to be included too.”
