It’s a mug’s game Jon!

Jonathan Stapleton has written a deliberatively provocative piece in Professional Pensions which will be applauded by the operators of workplace pensions but is going to get short shrift from me.

You can read  Jonathan’s opinions here.

The gist of Jonathan’s argument is that price pressures on providers is forcing them to skimp on the quality of the investment default.

The pressure to reduce costs has not only meant payback periods for providers have been extended but also that the amount of money available for the investment content in the default offerings of these schemes has been squeezed ever further.

Members opting for a default offering in any major scheme are unlikely to receive anything more sophisticated than a passive lifestyle default. And, given that over 95% of people choose the default, this matters, especially at a time when the next financial crisis could be just around the corner.

Perhaps the time has come for us to adopt a different tack. To start choosing value for money over cost alone and, dare I say, paying more for our DC schemes.

Yes, members want low cost, and they don’t want to be ripped off by providers; but they also want a quality investment offering that will be robust in all market conditions.

I write as someone who has his entire DC wealth in a FTSE 50:50 global equity index tracking fund which I am paying 0.1% + 0.02% transaction charges. Jon might argue that I know the price of everything and the value of nothing. I would argue that I see no point in paying higher fees unless I have evidence of value. Other than NEST, I see no evidence of any particular value in the market. But as regular readers know, I am working on changing that so that we can compare apples with oranges using value for money scoring.

When we have accurate data that reflects performance over reasonable periods of time, then we can start assessing the validity of Jon’s assertion that you can buy funds robust in all market conditions.

The next financial crisis could always be just around the corner, like Chicken Licken’, we could assume the sky is about to fall on our head and no doubt it will.

Mark to market DC

In my short working career , the equity market has fallen on my head several times and I fully expect it to do so again. As a 55 year old expecting to crystallise in not less than ten years, I am under no delusions!

But as the conservatives will find out if they sack Mrs May, it’s one thing throwing out the incumbent, it’s another finding an alternative.

My first message to Jon Stapleton is that equities remain the best long-term growth assets and there is precious little point in paying for diversification if you have no immediate liabilities.

Nurture your chickens instead

Pricing pressure is fundamentally downwards

While I challenge Jon’s premise that paying more for fund management will increase value as unproven, I further challenge the assumption in his article that the operator’s  “fixed” costs and margins, that make up the majority of the AMC are “fixed” at all.

and where does the line go after 2038?

He points to NEST which will continue to accrue debt till 2029 at which point it will owe the DWP £1.2bn He does not mention that in a few short years following 2029, NEST will pay all that debt off and then become the biggest cash cow Government has ever owned.

Well that’s what the NEST projections tell us, and this of course assumes that NEST costs remain constant and that pricing remains constant too.

But of course NEST’s current fixed costs are likely to change over time and I have to conclude that they will fall, as will all providers’. Here’s why.

1. the adoption of distributive ledger technology; as NEST’s former CEO Tim Jones tells me, pension administration has yet to grasp let alone adopt the benefits of the block chain.  When it does, the manual processes that cost NEST and its competitors the bulk of its record keeping fees will fall away, making records more secure, easier to access and a whole lot cheaper to manage.
2. the increasing ability of the public to self-serve; NEST – like most of its peers does not run an app to give members instant access to their pot and the capacity to manage it. This is because it has not yet confidence in the security and accuracy of its records (see 1 above). Following improvements in record keeping, operators will be able to pick up on people’s increasing capacity to do simple things for themselves. Assisted by artificially intelligent bots, taught by machine learning, we can – in time – self-serve!
3. taking out the slack in fund management; the 36% margins enjoyed by fund managers and their cronies are not sustainable. Greater transparency caused by regulatory and consumer pressures (bravo to the TTF) mean that both the AMCs and the fund expenses of all pension funds are going to come down. This can either mean we get more for the same money (if Jon’s belief in buying robustness is proven) or that what we are currently paying fund managers will reduce. As we have no way of knowing what we are paying for fund managers (see my bleating about NDAs) , we currently cannot put pressure on fund management margins but that is going to change and very soon.
4. Consolidation drives scale and reduces prices (eventually). Right now BlackRock is owned by Aegon, Friends is owned by Aviva and pretty soon we expect Zurich to be owned by Scottish Widows. The smaller master-trusts are queuing up to be bought by bigger master-trusts, the only question is whether they have earned a price. We will see a contraction in choice but this will create greater scale and – in a market in which the CMA are taking a great interest, this will ultimately benefit the consumer.

Jon Stapleton is right to point to a short-term increase in the operator’s prices. NOW pensions is putting up the fixed costs charged to deferred members as it claims these costs are subsidised by the richer members. This is of course hog-wash, were it true we would see richer members seeing a decrease in charges, which is not happening. NOW is trying to stabilise its current financial position.

Hardly any pension providers are making any money out of auto-enrolment but that is not the same as “workplace pensions”.  The biggest DC schemes such as LBG, JP Morgan and HSBC now have billions in assets and present fund managers with fabulous long-term income streams. The bundled players such as Zurich, Standard Life, Legal and General and Fidelity who got in early and captured the elite DC market ten to twenty years ago are now very profitable indeed.

Profitability after 2038 will be huge (under lifetime pricing)

As the NEST chart shows, once you have reached a certain size, the operators of DC pensions can make huge amounts of money. Assuming that is, that people like me don’t go pissing on their bonfire and driving costs down. Why the operators are so resolutely against benchmarking, refuse to lift NDAs and write me stroppy letters when I write this kind of blog, is that their vision of “lifetime pricing” is complete baloney (and they know it).

We do expect the operators to finance the early part of a DC pension’s charges. We expect them to reserve for this or to explicitly state their borrowing (NEST). Even the non-insured master trusts are going to have to partially reserve within the next few months. We also expect for operators to recover the costs of this financing later in the contract and I am happy to see numbers which show them doing this.

But we do not expect to see the kind of profiteering that has been going on among the insurers on legacy DC (I am still paying 4.25%pa on the capital units of my Allied Dunbar pension bought in 1985).

Instead we expect to see prices for DC coming down as the massive surge in profits in the NEST projection, feed through.

The long-term profitability of NEST is immense

Workplace pensions are not here to provide the shareholders of insurance companies with windfall profits in the ten or twenty years time. They are here to provide members with good outcomes. A 1% pa reduction in charges over the lifetime of a contract means a 27% improvement in outcomes for consumers.

Right now, workplace pensions may be costing the shareholders, their pleasure is downstream, but they should not expect a gold-rush – unless they get the ongoing patronage of a munificent financial press, regulator, CMA and of bloggers like me!

ear ear!