Thanks to the FT and Peter Nellist from Exeter for this excellent letter.

You have put your finger on a crucial flaw in the Value for Money Framework.

Transparency required

Pension fund fees must be reasonable and clear

Moira O’Neill has rightly pointed out the danger for pension holders of money being invested in illiquid assets (Opinion, July 14).

There is another danger lurking in the Mansion House speech. Referring to the “value for money framework” to be published the following day by the DWP, the chancellor said that the framework was “clarifying that investment decisions should be made on the basis of long-term returns and not simply cost”.

The framework itself, at paragraphs 50-52, summarised the responses to reporting investment returns “net or gross” with the direction of travel appearing to favour gross returns.

Charges are of fundamental importance: a principle recognised by parliament’s work and pensions committee when it recommended a cap of 0.75 per cent on annual costs to be taken from workplace defined contribution schemes.

The effect of charges could exceed the 12 per cent increase in investment value that HM Treasury predicts. If you are a custodian of an individual’s pension pot, there is both a moral and commercial imperative to levy transparent and reasonable fees.

VFM is about what you get, not what you’re promised.

Peter knows his stuff, that he’s bothered to read the DWP’s response to the VFM Framework is impressive. Even more impressive, he’s picked up on the inherent weakness of allowing fund managers to quote performance gross – it means punters get the fund manager’s spin on performance , not what savers are actually getting from their investments. This is important not just for workplace pensions, but for wealth management. This is as much an issue for the FCA as TPR.

There are transparent ways of valuing illiquid assets. The simplest is to see what you could get for your investment by asking for a quote.  I anticipate that many savers who are in defaults heavily invested in illiquids will request transfer values online and smart ones will compare the rate of return they’ve got with what the manager is saying they should have got. If I had an adviser, that’s the kind of work I’d like him or her to do.

If you are investing in an investment trust which holds illiquids (like Disruptive Capital’s very transparent Long Term Assets investment company), then what you can realise your holdings at , is available to you from the market – typically with a discount to the asset value stated by the investments. That discount represents the likelihood that – were the investment to be actually sold- you’d get the full price. It is the true price, net of all costs and all risks perceived by the market in holding that stock.

The problems occur when you buy at the full price and sell at the discounted price and this is where I suspect Peter Nellist is heading. (I note Peter had a similar letter published five years ago)

The only way we can properly assess value for money is on realized value, not on the artificial values quoted by  rarely traded illiquid funds.

If we aren’t careful, we will start allowing DC funds (especially the commercial ones) to artificially inflate the realizable value of illiquids in their VFM reporting. Netting off fund charges doesn’t help as the spread that matters is not the quoted charge but the difference between the fantasy and realized price of the asset. Quoting fantasy NAVs may give you a green flag on your VFM assessment, but it sends a dangerous false flag to savers and regulators.

Which is why I and AgeWage argue that the only way to measure historic performance is by looking at the realizable net asset value, what people can actually get if they transfer their pot. This can be compared with with the timing , incidence and scale of contributions made to get that pot to give the saver their true internal rate of return. That IRR can be benchmarked to tell  savers if the investment strategy is giving value for money.

That is real performance measurement, not measurement to suit the fund and scheme manager. The real cost to members of illiquids , is measured in the difference between what is promised and what people get.

Until the FCA, TPR and DWP wake up to the capacity of illiquid funds to game the sale price of units, we will continue to play fantasy pensions. Dreams are great until  the ecstasy ends , with pensions, that’s when people ask for their money back.