Workplace pensions are not priced as they seem.
When an employer chooses a workplace pension, he/she sees member borne charges and employer charges. The employer charges are paid by the employer as fees (anything from £0 -£1200 pa, member borne charges are expressed as a percentage of the fund (and sometimes a small monthly fee).
Most members believe that all they pay in costs for their workplace pension is the member borne charge.This is a misconception, some of the cost of running your workplace pension is paid by the member and is hidden
There is another misconception that the “member borne charge” we pay is buying fund management.
Infact, the cost of fund management to a workplace pension provider can be as low as 4% of the total charge levied to members.
We do not know how much workplace providers are paying the fund managers as their Investment Management Agreements (IMA) are not published.
If they were, we would find out that some default funds are costing as little as 0.03% pa (3bps) of funds under management (4% of 0.75%).
Which begs two questions
- How much of the cost of asset management is being paid by the IMA
- Where is the rest of the annual management going?
Here is a list of the costs declared by large Dutch Pension Funds to the Dutch Central Bank as part of their reporting obligations.
How pricing works
You will see that the basis point charge paid by these huge funds vary between 79 and 7 basis points. None of these pension funds are paying as little as 3 basis points. If we could see the IMAs between asset managers and workplace pension providers we could see what was covered by the agreement (and what wasn’t). Instead we have to guess.
There are a number of explanations that we could guess at to make sense of this.
- That British asset management is a lot cheaper than Dutch asset management
- That the Dutch Pension Providers are declaring more of what they are paying than their British Counterparts
- That the Dutch are buying more complex asset management than the British.
Let’s dismiss point one, many of the organisations on the Pensioenfonds list are also operating in the UK, you don’t start paying more for things as you step off the airplane at Schipol.
The second point is very important. We assume that what we call the Annual Management Charge is what the DWP have dubbed the “member borne charge”, but members bear charges in two ways- overtly (via a stated charge) and covertly, by deductions from the fund which don’t form part of the AMC but reduce the outcomes of the investment – the fund performance.
From these figures it would seem clear that what the Dutch say they are paying is likely to include a lot of the hidden charge paid in UK workplace pensions (but not disclosed).
Put another way, much of the fund management cost and charges may not be included in the IMA and is therefore being charged on top of the AMC by an adjustment in the unit price. We pay this extra amount through reduced fund performance
Comparing apples and pears
The final question is the old “apples and pears” comparison, are the Dutch spending more on asset management because they are buying a Rolls Royce not a Mini?
This presentation by Novarca explains that the total cost of asset management in the Dutch system takes into account more than just the fees paid to asset managers. The presentation is about the Institutional Benchmarking Institute(IBI) , which analyses 85% of all funds in the Dutch system. When they make apples and pears comparisons , they look at value for money and help the Funds work out whether they are getting it.
This includes obvious items such as an analysis of what assets are being managed and the likely impact of the asset mix on net return.
This includes an analysis of the active/passive mix and the cost of attempting to get extra performance relative to the likely outperformance (Alpha) being generated.
This includes an analysis of the implementation of overlays on the asset management such as interest rate hedges and the effectiveness of these strategies.
And because they do this well, 85% of Dutch pension assets are being analysed by an external organisation (www.institutionalbenchmarking.org) to see whether they are delivering value for money on everything from transaction costs to stewardship.
The IBI analsyse Dutch Pensioenfonds on
- an index for asset allocation
- an index for alpha generation
- and an index for the implementation of overlays.
they also use a transparency index which tells the asset owner whether all transaction costs are being fully disclosed.
By looking at all these factors, Dutch pension funds can compare apples with pears and establish on a simple matrix whether they are getting value for money.
In the matrix above (taken from the presentation of how the IBI system works), Pension Fund A (PfA) originally looked to be paying a lot less than Pension Fund B (PfB). The matrix shows that PfB is delivering better value for money than PfA.
Why this matters
In the UK workplace pension system, the member of the pension bears the fund management charges but has no idea whether he or she is getting a good deal or not.
As the matrix showed, what looks like a good deal (PfA) turned out to be a poor deal relative to PfB even though PfA looked cheaper.
At a very simple level – cheapest isn’t necessarily best.
But it’s a lot more complicated than that. If we were to run our workplace pension default funds through IBI’ transparency index, we might find that what looked like a 0.50% member borne charge was a lot higher than that. If the declared cost of asset management is typically around 0.5% but pension providers are paying as little os 0.03% for a fund (as we are told is happening under some IMAs) then the difference must be being picked up someone somewhere,
I pay 0.13% as my overt cost for the Legal and General Multi Asset Fund, but a very similar fund is being bought by SIPP provider True Potential on behalf of customers for 0.41%. Am I doing well and is a big fat SIPP provider being ripped off? Or can the difference be explained by using the IBI benchmarking service. Could it be me that’s getting the worse deal? Or are L&G just charging us both fairly but in different ways?
It matters to me – matters a lot!
Over the course of a lifetime, paying an extra 0.3% pa for fund management matters, it matters by about 10% of the outcome. Put better, the person paying a lower cost (Assuming apples v apples) is giving himself a 10% pay rise from his pension.
I intend to be invested in that L&G fund for a further 20 years – I want to know what value for money I am getting. Paul Trickett, I want to know from your IGC!
Why aren’t we using these indexes?
85% of Dutch Pension Funds are using the IBI benchmarking indices
0% of the UK Independent Governance Committees came up with a way to benchmark their fund management costs.
The Dutch pension system is recognised by the Mercer Index and OECD for its governance and in particular for its fund governance.
When Novarca offered to work in the UK for the FCA helping to develop the IBI benchmarking service to meet the particular needs of our workplace pension market- (its trustees and IGCs) – the FCA promoted their approach and called for evidence for and against. That was a year ago and we haven’t seen what that call for evidence produced.
My gut feeling is that the providers of workplace pensions would struggle to disclose data to the IBI index, not because the data isn’t available, but because by doing so, they would lifting the lid of Pandora’s Box.
What would fly out of Pandora’s Box?
The most obvious worry for the asset managers and the providers is that some funds would perform badly on the transparency index and would be shown to costing members considerably more than declared. In some cases, this would show that members were paying well in excess of the currrent charge cap (0.75%)
The less obvious but more insidious worry is that once the lid was off workplace pensions, everyone else would want to know what they were really paying. This would be particularly difficult for asset managers who might be offering similar products to different customers at radically different prices. The question would be whether retail customers were being treated fairly.
An expedient solution or sweeping dust under the carpet?
In order to keep a lid on the box, the insurers who run IGCs are looking to set up there own benchmarking service which will avoid the kind of tough scrutiny set out in this document.
The benchmarking service they have in mind would be a lot cheaper, more expedient and (I suspect) effective. I do not think that it will help me understand whether I am getting value for money from my workplace pension,
I do understand that plans are well underway to announce this service to the world.
Having seen how the Dutch do things and having spent some considerable time worrying about pricing of workplace pensions, I am convinced that we properly need to know what we are paying for when we give our money to asset managers.
I am keen to know too, what I am paying for every month for that part of my AMC which is not being used to pay the asset managers ( which can be up to 96% of the overt charge). But I am not so worried about that, I can see where that money is going!
What I want
I don’t want VFM swept under the carpet, I want a way to compare the value for money that I get if I invest in NEST, my occupational DC pension fund and in my Legal and General workplace pension (for example).
There are 1.5m small employers who need to be able to choose their workplace pension with confidence. To understand value , they need to get to grips with price.