While investment consultants ponder the fifty shades of grey of diversification, I ponder just who , outside a small number of “experts” is prepared to take a decision on the default investment option of a company’s defined contribution pension scheme.
This question is of enormous importance and while it may not matter much tomorrow (as say whether Rooney can still head a football), it will be a crucial matter for those retiring from the workplace savings scheme being set up and managed today.
As far as I can see, most schemes end up with a default by default. Put another way, those who select the DC provider have no more idea or interest in the default investment option than the member.
I don’t see any great investment expertise among those who select DC arrangements, typically they are drawn from the Boards of our companies, large and small, they may have picked up something from sitting on DB trust boards but are they qualified to take DC default decisions? – NOT OFTEN!
If they are neither expert enough nor interested enough, attention turns to other fiduciaries, what about those who run the platforms on which the funds sit? Well here the story gets more interesting.
If you run a DC plan as a means of getting your funds into play, then you cannot claim to be a fiduciary, you can at best claim to have given fiduciaries your best offer.
If you run a DC platform on an “open architecture” basis, you are theoretically promoting all funds on a level playing field – eg not promoting one manager or one fund above another.
The fact is that open architecture platforms typically run as their default accumulation fund, a passive global equity fund. The reason is that they are competing with other funds on a quantifiable metric – “price”. The cost of the global fund to the platform manager may be no more tha 0.02% but the price that the punter pays for it after all the admin and comms (and commissions) can be anything between 0.10% and 1.0%.
You can see the huge spread in prices here. It’s true that some DC punters pay ten times as much for the same thing (with the same platform provider).
The platform provider have more of less forced the Fund Managers out of direct pension provision. Nowadays, if you want to get your funds to be bought by DC investors you need to get them onto the DC fund platforms run by the big insurers (now called providers).
This is where the crunch comes. If the platforms are being assessed on the price they deliver their funds, they will always showcase their cheapest fund in the beauty parade. This means that a company are going to have to make a deliberate decision to chose a more expensive option.
Fiduciaries are catching on now to the impact of extra expense. They recognise that by chosing a default fund with higher charges they are taking the risk that if the fund does not deliver higher returns, they will be open to criticism. If they cannot properly understand why the more expensive fund is better or are not interested in understanding, then they will stick with the cheapest option.
There is nothing in it for an adviser, they won’t get a penny more in fees by recommending an expensive default and so most advisers do not press the issue. Indeed most advisers will encourage conservative decision-making as the upside (outperformance) will not attribute to them while the downside (underperformance often as a result of higher fees) – will!
This creates an enormous skew towards passive low-cost defaults. This skew results in most DC plans having passive DC defaults purchased as the low-risk option.
The only thing that corrects this skew is self-interest among an adviser or a fiduciary. Where we see this self-interest creeping in is where the adviser is also the fund manager. Increasingly we are seeing advisers promoting their own expertise as fund managers with the price being paid by the member through the fund charge.
This has caused the price of some defaults increasing not to 1% but to 2%, that’s twenty times as much s the price paid by some DC investors. Firms like Towry and Mercer who charge their investment fees within the fund charge paid by the member are in one way to be commended, they are staking their reputations on the outperforming their extra charges should bring- no outperformance- damaged reputation.
These advisers have taken a view that higher charges are worth paying when they are being paid to them – some cynical commentators have detected a conflict of interest here.
Frankly , I see adviser charging on default funds as an aberration. I see NEST‘s 0.30% fund charge as the one to beat and frankly no adviser charged fund is going to get near that unless it’s subsidised by an employer or other sponsor.
There are some genuinely low cost alternatives to NEST , NOW is equivalently priced and has a properly diversified fund (albeit without alternative choices). These two “biggies” can compete on price with the low cost defaults and offer something more. Legal & General also offer a diversified alternative to a global equity fund.
However my conclusion is that for now we will continue to see DC plans purchased on price and DC defaults continuing to race to the bottom (of the price list).
The simple reason for this is that there is no Fiduciary Structure in place for that to change. There is insufficient investment expertise, insufficient advisory motivation and no appetite for the risks associated with doing anything other than what everyone else is doing.
If we can get the equivalent of TKU (trustee knowledge and understanding) into the DC governance space (whether trust or contract) then perhaps things will change, but that is a big ask. My sceptical view is that we are seeing no great improvement in the knowledge and understanding of DC decision makers and as defaults continue to dominate, those decision makers are those who chose the defaults- the sponsors,trustees and providers.
The fact is that no-one is chosing these funds- they are Japanese Knotweed!
There is of course one other person who could make the choice (unless you’re in NOW). That person is not acting as a sponsor, or a trustee or a provider – that person is you!
Fancy the decision?
I’d be interested to hear from you if you do!
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