The defined contribution industry has been moving to offer more flexible solutions to smooth the path to retirement for some time now. Bog-standard insurance funds are being consigned to the dustbin and in their place are lifestyle funds, target date funds and diversified growth strategies.
And in the trust-based sector, blended funds, offered by the major consultants are coming into vogue. The question is whether these blended-solutions are ripe for smaller advisers and for contract-based DC schemes.
A blended fund is set up by an intermediary requesting that a specific insured fund is created for a large employer-sponsored DC scheme.
As it stands the arrangement will usually be trust-based so that the trustees, advised by the EBC or corporate IFA, are able to instruct the provider how the fund should be invested, selected from a range of underlying insured funds. It is not too dissimilar to a fund of funds arrangement.
A single investment instruction from the trustees is all that is required rather than an instruction from each and every member of the scheme. In this way the EBC aims to deliver a high value and highly tailored solution for the employer sponsored scheme.
Many in the insurance industry suggest that one of the main reasons for the growth in blended funds is that the unbundled DB market is gradually shifting to a bundled DC market. At some point they argue there will be a tipping point where the scale of the assets within the arrangements tips from being mainly DB to mainly DC. Some argue that as this happens EBCs will look to defend their business position by extending the range of services typically offered to the trustees and employers of large DB schemes into the new DC arrangements.
Mercer is one of several consultants that offers services such as bundled solutions, combining “a full suite of pensions and other savings products, overlaid with Mercer consulting and governance”.
John Lawson at Standard Life says: “As far as blended funds are concerned, the big consultancies are planning to use their own in-house expertise to design funds – so rather than using Standard Life’s or another provider’s solutions they would construct bespoke funds for one or a number of workplaces that meet the needs of members of those schemes, and charge for that service accordingly. That means they can gain fee income from normal consultancy, through employer trustee advice, and from investment consultancy.”
Several experts reckon that it will be difficult for a blended arrangement to migrate over into a contract-based DC arrangement such as a GPP – for the simple reason that the adviser would need to have discretionary authority from each member to make the investment decisions on their behalf.
Lawson says: “The issue in contract land is that the provider is ultimately responsible for the default, so has the ultimate power to reject the use of a particular blended fund if they feel it is unsuitable for the group of employees at which it is targeted. This raises some issues – how comfortable will consultancies be with providers having sanction over their activities? And, if they are uncomfortable, are they more likely to recommend trust-based schemes if they think the trustees will be more accommodating?”
But others reckon that the blended arrangement could be made to work in both the trust and contract world.
Ewan Smith, marketing director at Scottish Life points out that in the DB space services involve traditional scheme valuation actuarial work as well as asset liability management and fund manager selection and review. Not all these services translate over into the DC market but one that does is investment governance of the default fund, used by the vast majority of the employees, and a highlighted list of funds, selected from the full range available.
Smith adds: “The default fund could be a single fund such as a balanced managed fund or a lifestyle strategy, that automatically de-risks as the member approaches the retirement point. A further enhancement to this is the blended fund option – where a bespoke fund is created for that employer and invested according to the trustees’ instructions as advised by the EBC.”
One of the issues of blended funds is that they will charge an extra percentage here or there for their expertise. This could prove an attractive proposition to firms in the post-RDR world when commission has bitten the dust.
But again the industry is divided on how the regulator interprets blended funds offered by IFAs and EBCs and whether they come under the FSA’s distributor influenced funds umbrella.
Julian Webb, head of DC and workplace savings at Fidelity expects that in the main advisers will be in the clear because the advisers’ role is to advise their client of the content of the blended fund and the parameters for and frequency of rebalancing. They are not directly managing the clients’ money so do not fall foul of the FSA requirements on distributor-influenced funds, he argues.
Webb adds: “Once the structure of the blended fund has been agreed between the adviser and the client, providers such as Fidelity will then manage the fund for the client and provide on-going oversight.
“The legal basis of contract-based plans is that they comprise individual contracts of insurance between the provider and the plan members. The employer is not directly party to the individual contract and therefore enters into a separate contract with Fidelity in respect of certain aspects of the design and operation of the plan including the use of client-specific blended funds. While the fund will have been advised by the employee benefit consultant, it is bespoke to the plan and not the adviser.”
So can a blended-fund be considered a distributor-influenced fund (DIF)? Some reckon that where an adviser has the degree of influence and responsibility for the investment proposition set out above then it is likely to be considered as a DIF.
And herein could lie a problem – DIFs are a major concern to FSA and it has issued guidance to remind IFAs of the rules relating to them.
Speaking at the Tax Incentivised Savings Association (Tisa) DIF seminar recently, Peter Smith, the head of investment policy at the FSA said: “We expect it to be difficult for firms to prove advice on distributor funds is unbiased or independent. There are clearly conflicts of interest and any conflicts of interest need to be managed in a way where the firm ensure they are providing unbiased and unrestricted advice.”
Smith said the regulator would also be watching restricted firms to ensure any advice on funds they were giving was suitable for their clients and needed to “show that this is the case for each and every customer”.
And this is another issue if blended funds are deemed to be DIFs – can advisers be sure that the solution is suitable for all members?
Where an adviser firm has the right resources, skills and regulatory permissions, these arrangements can be effective in delivering good client-focused solutions. On the other hand there is a risk that the adviser firm simply does not have these skills and that the employees end up in an unsuitable arrangement in terms of both cost and poor performance. This, say some, is a particular concern in the pension transfer market.
Lawson’s view is that blended funds are DIFs and, therefore the IFA, would not be able to make money out of this activity. “The end customer, the member in a GPP, is a retail customer so that may influence the FSA’s view. If the FSA does rule that blended funds are DIFs then the consultancies may simply charge the employer for the cost of blending rather than this being reflected in the fund AMC.”
Most experts agree that it would be very difficult for most corporate IFAs to manage pension investment funds. They would have to be responsible for asset allocation, fund selection and rebalancing and this would cause a long administrative tail for many companies, which would not be cost efficient.
It is also why funds such as Scottish Life’s “governed” range are aimed at providing more of the large scheme investment process to the smaller scheme, without the need for individual member agreement to each and every alteration. Other solutions for members of GPPs, that provide a known level of risk control while having proactive management of assets allocations, are funds such as the Standard Life “my folio” funds.
AWD Chase de Vere is one IFA that looked at taking the blended fund route but decided not to pursue.
Patrick Connolly, head of communications at AWD says that offering own fund solutions is more viable for the larger corporate advisers who will benefit from economies of scale, particularly if they are working on behalf of a large number of clients.
He adds: “Running and recommending your own investment proposition is fraught with complications and is something that the FSA is looking at closely. As a starting point, the corporate IFA needs to understand who their client is. Is it the employer or the individual member?
“If members are recommended or encouraged to put money into a fund where the corporate IFA receives a greater level of remuneration this has to cause a potential conflict of interest between the adviser and the member and there must be serious questions about whether members are getting the best advice.”
Lee Smythe, managing director at Smythe & Walter Chartered Financial Planners suggests that the problem for smaller IFA firms is that the majority of schemes, upon which they advise are GPP’s – and as such the fund choice is down to the member.
“Even if an option existed – default or otherwise – to have the pension fund “managed” in a blended way, it would most likely be necessary for the IFA to have discretionary investment powers, otherwise each fund alteration would need the prior agreement of the individual member and this would of course not be practical if you were trying to operate a strategy across the board.”
“Besides I do not think that there will be a great deal of scope, in the main, for IFAs to charge additional fees to provide investment management services which can be bought off the shelf from the scheme providers themselves.”
So can blended funds work? The big consultancies obviously think so, but mutterings from within other areas of the DC sector wonder whether they are generating fees and protecting their interests as the shift from DB to DC intensifies.
Andrew Cheseldine at LCP questions whether the move to blended fund solutions is a genuine attempt to build better lower risk /higher return net of fees pension funds or an attempt to increase fee revenue.
“What exactly are they offering? Long, medium or short-term asset allocation? It seems to be almost entirely medium term, so they are still leaving the short-term work with managers – what is the relative added value? Even if you are a very big consultancy with considerable resources, why do you think that you can do even the medium term asset allocation job better than investment managers who have years of experience at it and even more resources?”