Higher costs – lower pay-outs? Fact or fiction.

pantry2

Shedding light on financial markets

This is the first of seven blogs I will write, that will by September 3rd, form my submission to the Work and Pension Select Committee’s inquiry into pension transparency.

Today’s exam question is;

Do higher-cost providers deliver higher performance, or simply eat into clients’ savings?


 

My Simple answer;

So long as we have the right data and the means to analyse it, we can answer that question “fund by fund”, “product by product”.  The aggregate of all the answers will eventually enable us to generalise.

There is no short cut – the task is massive but it is one that is within the compass of data scientists and one that the pensions industry could and should undertake


We may start with a prejudice – we should end with clear evidence.

Consumers start with a prejudice, that prejudice is that we are being ripped off.

Robin Powell, the evidenced based investor, has written extensively on this topic, showing time after time examples where the money we’ve paid for “intermediation” simply hasn’t delivered value.

Not only is the “net of fees” position,  usually worse for the expensive investment option , but the gross performance – based on the net asset value of a fund from one point to another, is often demonstrably worse – the more meddling is done.

I deliberately use the word “meddling”, it’s not one you’ll hear in fund management circling, but that’s the kind of down to earth language needed, if ordinary people are to be part of the conversation.

Robin is probably right and his body or work has got us to a point where a Government Committee is asking the question. But we need to go beyond prejudice – there are no easy answers. Answers come from evidence.


Too much meddling.

The cost of “meddling” – buying and selling stock, purchasing derivatives to offer hedging, gearing, capping and collaring is met by the funds beneficial owners. Sometimes these costs are upfront and acceptable. Anyone who’s considered paying  a fee to fix their mortgage will be familiar with the trade offs. But whereas the banking instruments that provide certainty of outcomes when we borrow money are transparent, those that we buy to protect our savings (especially to provide protected growth) aren’t.

“Meddling” is almost always in the interests of the intermediaries who win whatever the outcome, but it is considerably  harder to see the benefit to the ultimate beneficiary. The nature of long-term saving leaves those who sold the product unaccountable for the outcome, while those there at the end of the investment can talk to the future, without reference to the past. You could call this the “asymmetry of accountability”!


Not enough accountability

Since most management teams within investment houses , move on regularly, the concept of ownership of “other people’s money” is low in priority. Sales targets are rather more common than “claims targets”. Unsurprisingly, there is little accountability for outcomes within the banks and fund management houses that create the products that we buy.


Nor transparency

The impact of the various instruments within the products we buy – on the returns we get, has seldom been analysed. But this is changing. The point of “transparency” in financial services is not just to shine a light on what is coming out, but to ensure that there is accountability for these costs (if only at the point of sale).

Fidelity has this month, launched in America, two funds with “zero pricing”. These funds generate revenues for Fidelity – purely from the lending of stock within the funds, to third parties (revenue kept by Fidelity rather than passed on to the investor). This transparent approach to revenue sharing is in sharp contrast to general practice. How many of us know whether stock lending is going on within our fund, who benefits from it and the risks attached? If it is possible to run a fund on stock-lending revenues alone, why do we pay so much for funds that are doing nothing more than the Fidelity zero priced funds? What are we paying our annual management charges for?

The lack of transparency among banks and investment managers around these questions, has led to a lot of head scratching not just among consumers. It’s also excited Regulators. Last year, the FCA decided to do something practical to improved transparency at an “institutional level”. By “institutional”, they meant  “business to business” . It was felt that if professional purchasers of fund management (including pension fund trustees), could find out what the real cost of all this “meddling” was, then the end consumer would follow.

The result was the Institutional Disclosures Working Group whose task was to create a template that allows buyers to see what they’ve purchased and to monitor the money and the value of the fund management they are getting. This , alongside other regulatory measures (MIFID II, PRIIPS) will – it’s hope- mean that the asymmetries of “information” and “accountability” will be redressed. Consumers -whether institutional or retail – will have a way to address the WPC’s exam question.


We can answer the question using “value for money” as our measure.

The only way for us to know whether higher cost providers are giving us value for our money is through data. Many providers will talk of “engagement” as an end in itself and will point to fancy portals, dashboards and other gimmicks. These is really nothing but marketing , a way to throw the bloodhounds off the scent.

We answer the question by looking at the Net Asset Values of a fund from point A to point B and then compare it with the gross performance of the fund and the difference in terms of fund performance is the “money” we have spent on intermediation – on management.

We then compare the performance achieved on a “net to net” basis, with the promise made by the fund, that is the value. And once we can get the value and the money, we can get the value for the money.

If we want to compare the value for money of Fidelity’s zero priced fund with the equivalent VFM for the BlackRock, Legal and General or Vanguard equivalent, we can do. It may be, once we’ve assessed the risks of stock lending or the impact of reinvesting stock lending revenues in the fund, that Fidelity’s offer doesn’t seem so good after all.

Similarly, if we want to compare a complex structured product like a pooled LDI fund, we can use the same method – the same template and data capture, the same rigorous analysis of the resulting information. Nothing should be beyond the scope of data analytics, provide that the right data is captured.


If you do not supply the data, we must assume the worst

If a high or low charging provider will not produce the data needed to capture value for money, we must assume that they have something to hide. If we do that, then all kinds of red flags should be thrown and investors should look to leave in droves. Of course mass desertion from a fund causes its own problems, but it is the only sanction that us consumers have.

It is unsurprising that the trade bodies of the fund providers (ABI and IA) have fought tooth and nail against disclosures of net and gross fund performance and the breakdown of costs within their funds. The asymmetries described have kept them in clover for generations.

However, we are experiencing a revolution – a digital revolution – that means that collecting – analysing and publishing analysis is now cheap, easy and fun. I use that last word  with tongue in cheek!.

The illustration below, shows how I would like to see value for money scoring displayed. I would like to see my personal pension with Legal and General , compared with those of the alternative providers and I’d like to see the score displayed as simply as it appears on this mock-up below (all numbers fictional).

age wage simple

If we can see behind these numbers, the working that goes into these numbers, then we can answer the question set by the WPC.

But that task will be massive, it will involve analysing the funds of thousands of providers (both unit-linked and non-insured), it will involve analysing the contract and trustee charges of thousands of providers and schemes. In short it will involve “mapping the pension genome”, something that will be as important for our financial health as the mapping of the human genome was for our physical and mental well-being!


Submissions

This and the following eight blogs will be submitted in their native form and that will include comments. If you want to contribute, either anonymously or using your real name, post a comment.

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in advice gap, age wage, pensions, WPC and tagged , , , , . Bookmark the permalink.

2 Responses to Higher costs – lower pay-outs? Fact or fiction.

  1. Meech, Colin says:

    P

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s