And so the pension charge cap farce rolls on. Auto-enrolment workplace pension schemes were widely expected to be capped, possibly at 0.75 per cent a year, but with a broad expectation that the cap would come in from April 2014. But in a situation reminiscent of comedy duo the Chuckle Brothers ‘to-me, to-you’ routine, as quick as one publication reported the charge cap was to be shelved for at least a year, another has denied the claims as pure speculation.
Taking the star roles in this comedy of errors are Liberal Democrat pensions minister Steve Webb and his Department of Work & Pensions colleagues. At the time of going to press, no date had been set for the roll-out of a 0.75 per cent price cap – although a spokesman has confirmed that implementation will be later than the beginning of the new tax year.
It is hardly surprising that a measure of this significance has failed to materialise in the six months since it was first announced; a price cap will have major ramifications within the industry and will be clumsy to implement.
The Office of Fair Trading investigation into workplace pensions concluded in September that defined contribution (DC) schemes were over-complicated and difficult to understand. Furthermore, the OFT claimed that while large schemes were working well, many single employer trust-based schemes were not and the called for the Pensions Regulator to take action. Consumer rights body Which? called for crackdown on poor value schemes in which £30bn of pension savings languished.
Enter stage left Webb and his plans to uniformly lower the cost of pension schemes – ensuring members get value for money, and ‘rip-off’ DC scheme providers are no longer. But a recent study into pension schemes in Holland suggests that the DWP could be shooting itself in the foot when it comes to cost crack-down – and condemning a generation of pension savers to a small retirement pot.
The Pensions Institute meanwhile has published a report recently that argues 0.5 per cent is achievable for a decent default fund provided it is through a provider with scale, done under a master trust structure.
Investment charges on Dutch pension funds averaged 0.53 per cent exclude administration charges in 2012 according to figures from De Nederlandsche Bank (DNB). By comparison the OFT report into workplace pensions found UK pension charges averaging 0.63 per cent, including administration.Charges on Dutch pension schemes
The Dutch Bank collated figures from 278 schemes, showed charges range from 0.05 per cent to 1.1 per cent. The more expensive schemes had exposure to private equity, hedge funds and real estate, for which charges had averaged 3.43 per cent, 3.38 per cent and 0.87 per cent respectively. Although these alternative assets pushed costs up, these were also the schemes that tended to deliver better returns.
A spokesman for the DNB said that relatively high investment management fees do not automatically imply that pension funds are overcharged.
“The level of fees paid depends on the size of the fund, its asset allocation and the extent of active asset management,” the statement read. “A larger allocation to relatively more expensive alternative investments and a high degree of active management cause relatively higher fee expenses. It is up to the funds to offset the more favourable risk/return characteristics of these investments, owing to their alleged diversification benefits, against their higher costs.”
In essence, while a price cap is admirable – too much downward pressure on pricing goes against modern portfolio theory. In order to maximise portfolio returns, investors must take on a calculated amount of risk. Pension scheme members need exposure to both alpha and beta, and a combination of uncorrelated assets in order to ensure an attractive retirement income. This means a diversified portfolio, including alternative assets, which push up charges but also reduce volatility. This risk management is paramount to pension schemes, especially in lifestyle funds.
AllianceBernstein managing director, pensions strategies group, Tim Banks said that more expensive investment strategies will incorporate more investment sophistication, and features designed to get a better risk/return trade off.
AllianceBernstein’s flexible target date funds incorporate strategic asset allocation advice, dynamic asset allocation techniques and embedded governance for 30 basis points.
“In our view, pro-active management of the asset allocation – strategic and tactical – is where the greatest value is created,” he said.
This active element is in danger of being eradicated if a price cap is introduced.
“A price cap could place even further downward fee pressure on the investment component of the default,” says Schroders head of institutional defined contributions Steve Bowles. “Beta is cheap, alpha is not. DC is an environment where it is real outcomes that matter, rather than relative performance.”
Aegon UK regulatory strategy director Steven Cameron says that the imposition of a price cap will restrict how much can be spent on administration and active fund management. “The price cap will mean certain approaches to fund management or design of the default fund will not be affordable,” he said. “The move to DC places investment risk fully with the member, which has generated interest in controlling those risks or producing a more predictable outcome. But these come at a cost and some will no longer be feasible.”
If the range of options from which pension providers can build a portfolio is reduced, you could end up with members retiring within a few years of one another receiving considerably different pensions. Without a blend of assets, pension pots will not weather bear markets, say experts.
Even the OFT admitted in its report: “Charge caps create a risk of unintended consequences. Set too high, a cap can become a target for providers. Set too low, a cap can create incentives for providers to lower quality and/or impose charges elsewhere.”
To deliver any level of certainty of investment value at retirement portfolios need embedded guarantees or a third party to take on the investment risk – such as with-profits funds. But the transfer of risk from the individual to another party costs money. Certainty also requires product providers to hold more capital against those promises, to which an additional cost is attached.
There are alternative solutions for schemes wary of a charge cap. Jonathan Parker of Barclays Corporate & Employer Solutions suggests greater diversification and dynamic management within investment strategies, using behavioural finance techniques to improve DC scheme design and deploying collective DC scheme principles.
However, this combination of greater diversification and dynamic management – although cheaper than guaranteed outcomes – still costs more than a passive tracker fund.
Parker adds: “Risk management is important within DC because individuals do not like uncertainty, therefore using techniques to improve outcomes but stopping short of full certainty is the most sensible approach in a cost constrained environment. A charge cap will make outcomes more difficult to manage, but provided the cap is set at a sensible level, there are many investment techniques that can still be deployed to help manage outcomes.”
Auto-enrolment members have time on their side at least. Twenty five thousand employers are due to automatically enrol their workers into a pension between April and July this year and a higher aggregate asset base should over time drive costs down. The longer the charge cap is delayed, the better argue critics of the DWP’s position, as millions more members will be auto-enrolled – as long as they stay with the same employer long enough to reap the benefits of regular investing and compound interest.
“While auto-enrolment will increase the numbers of members of DC pensions, this won’t necessarily reduce the costs of administering such schemes. The main driver of cost is the profile of auto-enrolment members including how often they move between employers,” warns Cameron.
“Charge levels do affect retirement outcomes, but they are rarely if ever the most influential factor. The level of employer and employee contributions paid in has a far greater impact. Starting early and keeping contributing is the next biggest influence and this is where auto-enrolment will have greatest impact. Investment performance is also important and as highlighted, is difficult to predict. Charges tend to come next in the list, particularly against a backdrop of significant reductions in recent years.”
Hargreaves Lansdown head of pensions research Tom McPhail agrees. “The priority for the next few years should be to ensure that auto-enrolment is implemented efficiently and effectively, that as few employees as possible opt out and as many employees as possible who aren’t automatically eligible do choose to opt in. The imposition of a charge cap now would make all of these outcomes less likely,” he says.
“It is also important to note that in the early years of a pension, any beneficial impact of a price cap would be negligible. The difference between a 0.8 per cent charge and a 0.6 per cent charge on a £1000 pension pot for example, is £2. It is only in the later years, when the fund size grows, that any differences in pension charges become more relevant.”
Instead of focusing purely on price, Banks says that the DWP should focus on the complexity of some workplace schemes.
“Minimum quality standards in terms of the various DC components should improve the DC pension product, together with greater transparency around the various elements of pensions charges,” he said.
That is not to say charges at any level are justifiable. Now: Pensions chief executive Morten Nilsson points out that high charges, or even moderately high charges, have a very large impact on final fund values.
“Capping the overall percentage of an individual’s pension pot that can be lost to charges over the lifetime of the scheme would protect savers but give providers flexibility in terms of what they offer and how their charges are structured,” he warned.
“Delaying this decision creates uncertainty for the industry and for the tens of thousands of employers who are selecting a workplace pension for auto enrolment this year.”
It is an argument supported by the Pensions Institute, whose report last month argued that a value for money scheme should come in at 0.5 per cent, at the leaner end of the DWP’s range of options, a price for which some level of glide path management should be affordable.
The government’s pause in the process means both sides can pick up the arguments for and against a cap precisely where they had left off. But if, as has been suggested, the DWP is coming up against opposition to the idea of a cap from the Treasury, then all bets are off.