Alice’s world of “Look through”; exploring the DC fee phantasmagoria

“In previous consultations some stakeholders outlined that look-through can drive up the overall cost of investing in this type of vehicle to such an extent as to make it commercially unviable”

This statement is drawn from the DWP’s consultation outcome response on incorporating performance fees into the charge cap.

Many had thought that we had put this conversation to bed but the Chancellor’s announcement that he wishes to revisit the way the charge cap works forces me to rouse this sentence from its slumbers.

It translates as

“if we were to look at all the costs a member was paying in their default fund we wouldn’t be able to offer the fund and make a profit”.

You could turn this around and say

“We could make a profit and offer funds that invest in expensive illiquids, but we couldn’t tell our customers what they were paying”

This is clearly not what Rishi Sunak wants to hear. One of three things needs to give

  1. The costs and charges associated with these illiquid funds  or
  2. The platform margins of the workplace pension providers   or
  3. The charge cap protecting consumers from the impact of funds and platforms

What the Chancellor is saying is that the consumer is going to have to bear the costs of investing in productive capital.

Having spent a day in the swanky five star Four Seasons hotel “somewhere in a field in Hampshire” speaking to and with private equity, infrastructure and debt managers, I can report that almost everyone had to get to the hotel by car (the exceptions being those who used helicopters). The conference was exclusive because it was expensive and its carbon footprint must have been outrageous. There are many other egregious extravagances reported by fund managers on linked in every day.

This is what you see when you look through far enough

Fund managers do not make themselves popular by awarding themselves gongs at events like this and charging on the costs on to consumers. The conspicuous extravagance of the investment management industry is not something that should be funded by the pension pots of people who are struggling to pay to stay in their workplace pension schemes.

In a recent conversation with a private equity marketing manager, I heard a complaint that the initial screen by Nest when considering candidates for alternatives was made on price. The complaint was that Nest were only looking for a plain vanilla (beta) – the old “you pay peanuts, you get monkeys” argument. The comment reveals something about priorities, if the fund managers regard their fee structures as immutable, then platform managers and consumers must play to their tune. This does not sound a very good market to me. Nest has every right to demand value for our money.

It’s currently estimated that a very high proportion of the money raised by the private markets (£3 trillion at one estimate), is actually sitting in cash, waiting to be invested. This suggests that there is more money coming the private markets way, than the fund managers know what to do with. This further suggests that these managers have no reason to stop flying to five star hotels or any reason why they should drop their fees.

Back to “look through”

Re-reading the consultation I was surprised to find that look through is still not a requirement for DC schemes. This is  from Pinsent Mason’s response to the consultation.

The concept of look through appears only in guidance and not in legislation. Preferable if it was set out in legislation so that pension schemes trustees can invest with more confidence. Legislation could specify when look through applies in relation to particularly investment vehicles

Selective disclosure does not sound a good idea. But here we get to the Alice in Wonderland bit. Once you start chewing on the mushroom and looking through the various layers of funds that invest into funds, you can blow your mind and certainly blow the charge cap.

The Society of Pension Professionals compared the jobs of DB and DC trustees, the former can pay what they like for fund management as its the deep pocketed sponsor who picks up the tab  but

DC schemes have different barriers to investing in venture capital, of which fee structures versus fee caps is one.

So look through is not a legal requirement, its a barrier to investment and it seems to apply at the discretion of trustees who may or may not be telling people what their investments are costing them.

This blog was prompted by a question on twitter

The key to unlocking this door , is that performance fees are permitted by regulation as a charging mechanism but their disclosure is only subject to regulatory guidance.

The following quotes are taken from the guidance resulting from the consultation.

62.The effect of charges should be determined by an adjustment inclusive of all the charges, including performance fees, and transaction costs, which will have been taken from a member’s pot.

63. Where trustees choose to smooth performance fees over multiple years, as permitted by The Occupational pension schemes (Administration, Investment, Charges and Governance) (Amendment) Regulations, the smoothed fees should be used for the purposes of cumulative illustrations. It follows that it is only where the smoothed level of fees differs that a default fund should be treated as having a different charging structure solely because of variations in performance fees.

64. When demonstrating the impact of performance fees on a member’s pot in a cumulative illustration, where smoothing is being applied, trustees should use the fee notionally paid, i.e. accrued, by the member even if no performance fee is paid by the scheme to the fund manager at that time i.e. crystallised. In other words, if performance fees are being smoothed, trustees should demonstrate the impact of the smoothed amount on the member’s pot, not the underlying in-year performance fee. This is in line with the 2021 Regulations that permit smoothing as a charging mechanism not just a reporting mechanism.

Guidance says that look through should apply

The charges (similarly defined in regulation 2(1) of the Charges and Governance Regulations) should be forward-looking and take into account all of those a client will, or may, expect to be taken after investment into the product. The percentage rate (or pound amount, in the case of flat fees) used should be stated.

My answer to Jo Cumbo is this. There is no call for the impact of everything that’s eating into a member’s pot to be disclosed. The guidance says  that

Where trustees and managers choose to report the transaction costs associated with entering, exiting and switching between funds or arrangements, they should also show these effects in the illustration.

So the cost of (say ) a lifestyle transition is disclosed at a trustee’s discretion and is not subject to the charge cap. Looking through to the costs associated with transitioning from growth to defensive assets is not even discussed in the guidance. So long as disclosure is a matter of guidance and permissions are granted by regulation, look-through can be as distorted as Alice’s phantasmagoria.

Fair to the older member?

Jo’s question is about being fair to older members. Performance fees can hit elderly members disproportionately – because they may not get the full benefit of the performance but get the full cost of the charges (the bumpy ride). But elderly members face much worse issues from DC default management, including the costs of poorly executed lifestyle transitioning and of lifestyle design that is unsuitable for member needs.

While the apportionment of costs under performance fees is an issue , it is only one issue. In the wider world of “look through” where  there is no legislation but only guidance, it seems we have no standard practice. Despite the CTI tables, it would seem there is plenty of discretion. This doesn’t seem particularly fair to members old or young.

So will we get legislation or further relaxation?

What will be the direction of travel for the charge cap? Personally I favor a “look through” approach as it should stop the use of funds within funds and encourage direct investment with a minimum of intermediation. But for that to happen, trustees and scheme managers must know how to negotiate directly (without intermediate managers) and they will need to have the clout to do so – that means energy, skill and above all the power of a big fund.

Which is why consolidation can lead to a better deal for members and better member outcomes.

If “look through” was part of legislation, then it would need to look through to the impact of investment administration (the cost of buying and selling into funds) and it would need to focus on what matters to consumers – the total cost of ownership. But cost cannot be considered without value, while we can and should have legislation to ensure costs are properly disclosed and managed, we must pay much closer scrutiny to member outcomes which are much talked about, but little disclosed.

People have the right to know the net performance of their fund and net performance, when measured by their internal rate of return, will be the true verdict on the management not just of cost and charges but of experienced performance.


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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