It looks like the high-water mark for Government intervention in workplace pensions has been reached. The years following the introduction of the RDR saw the abolition of sales commissions (both for introducing members and setting up schemes), of “active member discounts” and finally the introduction of a charge cap , set at 0.75% pa of member’s funds.
The original proposals for the charge cap was that this would include all costs member’s incurred in the management of their money but the inclusion of “hidden costs” that impact performance but aren’t declared on statements, was dropped – to be reviewed at a later date.
Now , six years after the charge cap was implemented, the DWP has announced that it will not be including transaction costs in the charge cap and that the charge cap will not be reduced from its current level.
Instead, the Government plans to ban “combination charges” (that can whittle small pots to nothing) but only on the smallest pots (valued at less than £100). Although this has attracted headlines, it is but a nudge towards wider reforms which I hope will result from the work of the small pots working group. The problem is not with charges on small pots, but with small pots in the first place
Is this “news”?
The Pensions Minister has been trailing this announcement for some time and it should come as no surprise to regular readers of this blog. The Government’s agenda is not to protect consumers further. The high water mark of consumer protection was the charge cap (though you could argue that the master trust assurance framework is a more comprehensive governance measure).
Some on the left will see this as backing off effective regulation of the financial services industry, certainly Mick Mcateer falls in this camp and by the tone of her tweets, so does Josephine Cumbo.
From the Govt’s response to its pension charges consultation:
“There was a broad view that higher costs do not necessarily equate to better performance, but equally that lower costs do not necessarily equal better value for money either.”https://t.co/en2nkiZ4PU
— Josephine Cumbo (@JosephineCumbo) January 13, 2021
There is a substantial but little heard lobby within the Labour party and Union movement which sees the charge cap as the most effective way of delivering value to ordinary savers and will regards any relaxation in rules as a “thieves charter”. For them the lack of news on the cap and the Government’s reluctance to enforce the use of the CTI template in the disclosure of costs and charges as political and regrettable.
But “no news” will be good news for asset managers lined up to provide diversification to workplace defaults through funds where overt charges may be small but the vast majority of the charge sits out of sight.
The temptation for those designing financial products will be to load costs below the water line leaving savers with lower returns but the impression that they are getting more for less.
Making schemes accountable for delivery
There is a simple way to ensure that what is being delivered to members is value for the member’s money. Instead of relying on assurances based on projected returns and simulations of charges, trustees and IGCs could focus on what is being delivered to members by way of outcomes. This has the disadvantage of being retrospective but it is possible to retrofit funds using existing contribution data to see just how the performance tracks of diversified funds would have performed relative to the simple low cost products that have dominated defaults since 2012.
Trustees of DB plans, where investment into alternatives has led to mixed results will testify that “diversification is not always a free lunch”. Many of the complex diversified growth funds that came to market after the financial crash failed to deliver longer term returns and have now been withdrawn from the consultancy buy-lists, Standard Life’s bold use of GARS within DC defaults proved a costly move both to its reputation and to many member funds. Many of the complex strategies adopted by ambitious DC trustees have failed to match the outcomes achieved by simpler lower cost strategies.
The question trustees and IGCs should be asking is whether these were failings of the product or of the underlying assets. Nest’s recent announcement that it intends to increase investment in private markets from 9 to 15%, suggests that it sees better returns from private rather than listed equity, but Nest has both the management resources and funds under management to access these markets cheaply and to manage investments efficiently. Nest will be relieved that it can “enable access to a more diverse range of investments that offer the potential for higher returns” without having to increase the headline charge to members.
But to prove that private markets can deliver more to members , Nest needs to prove to itself that net of increased costs, there are long-term benefits which appear on the member’s benefit statements by way of bigger pots. Whatever the arguments for improving social capital by way of embedded ESG factors, value for member’s money must be at the forefront of Nest’s investment philosophy.
Re-reading my blogs written in 2014 when the debate about the charge cap was live and loaded, I can see that I have backed away from the hard line approach I adopted then. This may be because I have seen much greater awareness of the corrosive costs of hidden charges and of complex charging structures that can lead to the destruction of small pots.
But my distrust of the providers of financial services to workplace pensions has not reduced. If, as seems likely, asset and fund managers find ways to pass on elements of their charges that benefit their bottom lines through hidden costs, then this needs to be picked up, not just through the rigorous application of the CTI template but through the application of a standardized methodology for value for money which focuses on member outcomes net of all costs and charges (as well as the upside of improved returns).
While we have come some way to standardizing the way we measure cost, we are still relying on subjective and diverse measurements of value. Members need better information on the value they are getting for their money and that information needs to be based on outcomes.
Right now – the costs and charges argument is missing one important component, a measure for value that consumers can understand and use consistently. Only with proper information on value for money, can we really trust the financial services industry not to abuse the freedom which the output of this consultation offers them.
Moving from listed to private equity markets is almost certain to prove a step too far for most pension savers. The process of listing means that investors benefit from some rather complex, well- tested rules which provide protection to them. The listing rules also ensure that investors are subsequently provided with all relevant information. I very much doubt that any fund managers have the capacity to perform due diligence and create equivalent contractual arrangements for more than a handful of companies in any year. In addition, their monitoring of private investments will require time, effort and competent, qualified people. Investment banks, whose business includes bringing companies to market, handle only such a handful of introductions in a year.
There is a further dimension to this – breach of listing requirements brings with it market-wide sanctions and public opprobrium. The same cannot be said of a private contract dispute. The likely response of a company when in dispute would be to require a non-disclosure agreement as a condition of opening negotiations with an investor.
Finally, of course there is the loss of liquidity. The ability to sell easily is an important tool in the fund manager’s arsenal of disciplinary tools that may be applied to the management of their investee companies.