Thanks to LCP’s Dan Mikulskis for sharing these two slides on linked in. Dan is making some important points about his own profession . He’s commenting on an article that was written by one of his colleagues, Jennifer Davidson and asking the right questions.
The slides are detailed and I’ve blown them up as much as I can to help make those points
This is a slightly adapted version of Jennifer’s article
What LCP finds is that the asset allocation you need to achieve a set level of return above inflation has changed radically over the last 20 years.
Today you need quite an “adventurous” portfolio to deliver this level of return (even more so after fees). Back in the “good old days”, a gilt portfolio could have got you there and more. But has the industry adapted to this? LCP thinks that it hasn’t. Many propositions still offered today are expected to deliver less-than-desirable outcomes (in real terms and after the deduction of fees).
Two decades ago, you could get reasonable returns by investing in a relatively low-risk bond strategy such as a combination of government and corporate bonds. You could have yielded a 3.3% pa return above inflation by solely investing in UK government bonds (10 year gilts).
However, the current economic landscape paints a completely different picture for investors. Macroeconomic events such as the Financial Crisis of 2007-08 and the more recent Covid-19 Pandemic have driven interest rates down to historic lows, meaning lower-risk bond strategies can no longer deliver the level of returns seen in 2001.
Today, you have to invest in a far riskier strategy to have any chance of seeing your investments grow at this rate. This typically means you will need to invest a higher proportion in growth assets such as equities, property & infrastructure assets and high-yield bonds. As you can see in the chart above, to target a 2% pa return above inflation (before the deduction of fees) today, we estimate that you would need to invest 80% of your portfolio in growth assets. And to think, back in 2001, one could have easily matched these returns by simply depositing their money in a high street bank!
The impact of paying for the advice and platform fees
Jennifer continues , by looking at what fees do.
Think this is bad? It’s even harder to stomach once you allow for the typical costs of investing, such as advisory and management fees. LCP has made a deduction of 1% pa which might include asset management, platform and advisory costs. Some investors pay far more for this. For more information on fund manager fees you can read the LCP Fee Survey published in February.
In 2001, the government bond portfolio would have yielded a real return of around 2.3% after the deduction of fees. Today, however, to target a 2% pa real return, LCP estimates that you would need to invest 95% of your portfolio in riskier growth assets.
So what’s Dan’s take on Jennifer Davidson’s article?
So let me ask investment consultants some questions back.
Firstly, I don’t remember any consultants recommending to their clients that they invested 100% into gilts back in 2000, but if they had, would the schemes that had adopted that investment strategy be solvent? I suspect they wouldn’t because the financial instruments needed , weren’t available then, the bond durations were too short, so the 2001 strategy is notional – it’s abstract.
It suggests that in “the good old days” we didn’t need advice or platforms and that what’s happened since has forced us to create the increasingly complex strategies that are plotted for 2011 and 2021.
There is of course another argument, one that has been followed by savers in DC funds who have simply invested money in growth portfolios within default funds and paid minimal investment and platform fees and zero advisory fees. I have been doing this since 1984.
The reality for large DB pension schemes is different. Back in 2001, consultants were very active, choosing their clients active funds to invest in to improve still further the funding position of their schemes and in the process generating through analytics, beauty parades and transition management work.
In 2011, investment consultants were raking it in , setting up LDI strategies for the expected bout of inflation (which only turned up 11 years later). These LDI strategies generated huge fees for investment managers, platform managers and advisers
Today, we are seeing schemes which have been kept afloat by huge contributions from sponsoring employers, being asked to commit assets into private markets. LCP observe
For the past decade, we’ve seen a downtrend in investment management fees for institutional investors across most core asset classes. In our latest investment management fees survey, we find signs of that trend levelling off. However, there are notable exceptions in private markets assets which have seen fee rate rises since our last report.
Pension schemes have lurched from one expensive strategy to another, paying for change through advisory and platform fees. There has been very little accountability from those advising on these changes, for their success or failure.
My question to investment consultants is why consultants consistently find the most expensive solutions for their clients to use, and why those solutions always demand more services from investment consultants?
To put it another way
“who measures the value for money we get from investment advice?”.
LCP are asking awkward questions and these need to be asked as much about consultancy as about those who buy consultancy services (employers and trustees). LCP appears up for asking these awkward questions.
To go back to Dan’s statement on his linked in post
“this calls into question some real fundamentals of investing like balanced portfolios (hello 60/40 and DGFs) and de-risking / lifestyling into retirement. So, no-one really wants to tackle this as it involves bad news and awkward existential questions. So we get conversations like “what kind of stocks hedge inflation” and ” lets invest 5% in infrastructure”.
To which I would add “does the constant tinkering of consultants to meet supposed fundamental changes in the world, add much value“. Shouldn’t we think of pension scheme investment as requiring long-term strategies that play out over economic cycles , best left to play out over time?
The weird thing is that set and go strategies that expose people to the performance of real assets, seem to have done very well over the 40 years I’ve been saving. Investment, like economics – seems much simpler if you take the long-view!