Trust is a vital component of the relationship between adviser and client. While this statement is true of almost any profession, from a GP surgery to second-hand car dealership, it matters more in pension advice than almost any other for two reasons. First, the clients understand so little about long-term investing that they almost blindly rely on the judgment of their adviser. And, second, the stakes are high, the future lifestyle of the individual - and possibly their family as well - lies in the balance.
So it is alarming to find that a culture of trust between client and pension adviser or provider cannot be taken for granted. Last month (July) the Financial Services Compensation Scheme’s (FSCS) chief executive, Mark Neale, expressed concern at the rising level of claims linked to advisers recommending transfers into Sipps with risky investment strategies. The FSCS saw a 15 per cent increase in claims for the life and pensions advice industry during the last financial year.
At the same time, research conducted by Nest - the government-backed auto-enrolment pension scheme - found that the general public associated the pensions industry with gambling, corruption and incompetence: not the sort of name association pension providers would be looking for. The conclusion of Paul Todd, Nest’s head of investment policy, was that the pensions industry should stop complaining about the financial illiteracy of its clients and instead listen to their concerns.
The reality is that mistrust and financial illiteracy are two sides of the same coin. In any market where the buyer is extremely unsophisticated, the buyers’ behaviour is likely to be erratic. As soon as something happens that they do not expect and do not like, they flip from happy to angry and start mistrusting everything they are being told.
Blame for the breakdown
If a sales consultant recommends to you a high spec computer because it is the top of the range, only for it to break down the following month losing your photo archive along with it, who do you blame? The consultant, manufacturer or both.
The fact that the breakdown was due to a highly unlikely failure of its expensive digital components, compounded by the viruses you had accidentally downloaded without first backing up the system, is irrelevant to you, because you have not the faintest idea how computers work and do not care to, no matter how much the distraught consultant tries to explain all this. Unfortunately, pension savers have been hit by a series of crashes - stock market and otherwise - over recent years and the trust has evaporated.
Clients are no more likely to skill-up sufficiently in order to become sophisticated buyers of investment services any more than the rest of us are planning to take advanced IT qualifications before we buy our next iPad. We do not need to understand how it works - we just need to trust in the quality of product. In this regard, Nest’s Mr Todd is spot on. Pension advisers and providers should not expect their clients to skill-up, but they should clean up their act in order to regain trust.
No-one can prevent a stock market crash. But we can shine a light on one damaging, destructive and complex problem that does more to threaten our clients’ future lifestyle than anything else: opaque fees and costs.
A government consultation closed last month concerning the future of the Local Government Pension Schemes (LGPS), a collection of 89 occupational staff pension schemes for local authorities and government bodies across the country. The proposal on the table, put forward by major employee benefit consultancy Hymans Robertson, is that the LGPS ditch all £85bn worth of investments in actively managed listed assets in favour of passive investments and that they set up their own investment vehicles.
It is estimated this would save the LGPS - and, therefore, the taxpayer - £660m a year, or £6.6bn over the next 10 years, without damaging investment performance. This is money that would otherwise have been lost to the pockets of the global financial system. Is it any wonder that clients mistrust what happens to their money when they invest it through a pension?
The beauty of the proposition made by Hymans Robertson is that by switching from active to passive funds, not only are manager fees significantly cut but so are trading costs. Portfolio turnover adds hefty costs through commissions and spreads paid to brokers, costs that are rarely disclosed by fund managers and are almost impossible for anyone else to calculate accurately. Some researchers have put estimates of 1 to 2 per cent a year on these trading costs, but there is no definitive study - yet.
Under the bonnet
Given these costs, it is no wonder that so few actively managed pooled funds outperform their benchmark index, as independent studies so frequently maintain (see ‘The case for index-fund investing for UK investors’, by Vanguard and ‘The Governance Revolution’, by Charles Stanley Pan Asset.) The LGPS’ desire for setting up their own investment vehicles, rather than using existing ones, stems largely from the desire to see and understand the costs and fees that go on under the bonnet. Why? Because the trust is not there.
Pension advisers are not in a position to revolutionise the long-term savings industry. But they can help their clients to understand what happens to their money when it leaves their grasp. And the best way to do this is by investing in clean, simple and transparent vehicles. Inevitably this will involve pension wrappers and collective investment funds, and here advisers must be far-sighted because their clients are blind without them.
Pension wrappers generally involve layers of fees: find out what they are, calculate them yourself and keep track of them. Do not hide it from the client; be up-front about it. Next comes the funds: the annual management charge tells you how much the fund manager earns, but not what the total cost is to your client. The Ongoing Charge (the new version of Total Expense Ratio) tells you about the ongoing running costs of the fund - including custody and administration fees - but tells you nothing about trading costs (commissions and spreads); only turnover rates can give you an indication of this, and even then it is a vague approximation.
If in doubt, choose a passive fund or a fund with a simple investment approach: these are likely to have lower trading costs, although this is not always the case. Either way keep a close eye on net performance - this is the only way to tell how effective an investment is.
Not always what it seems
And finally, beware of spreads on fund units and individual securities - including Exchange Traded Funds (ETFs). Funds which quote a spread are effectively charging an upfront, initial fee - even if they claim on the literature that there is no initial fee. This can be particularly high for alternative funds which invest in illiquid, hard-to-value assets, leaving the investor showing a hefty loss the moment they buy the units.
The moral of the story is that capital markets are a jungle and investors need a guide they can trust. That is why pension consultants have such an important role to play, but if they cannot see where all the pitfalls lie, how can they safely guide their clients through without them getting bitten? It is not the clients that need to swot up, it is the advisers.
Bob Campion is head of institutional business at Charles Stanley Pan Asset Capital Management
